Should I Buy ARM Holdings for My ISA?

LONDON -- I am backing ARM Holdings  (LSE: ARM  ) (NASDAQ: ARMH  ) to remain on course for excellent earnings growth. Exploding demand for smartphones and tablets, particularly in the fruitful emerging markets of Asia, should continue to drive demand for ARM's tech savvy.

However, I reckon the current share price suggests the group's future growth prospects are currently priced in, while an unattractive dividend policy also undermines the investment appeal presently.

But bear with me, as I believe there are other fantastic opportunities with which to bolster your tax-efficient stocks and share ISA, one of which I'll mention in a minute (just click here for more information on how to maximize your returns from ISAs).

A strong sales processor
ARM -- which designs and licenses intellectual property in the semiconductor market -- saw revenue increase 21% in the fourth quarter to $263 million, bucking the enduring weakness seen in the wider semiconductor industry.

This excellent performance was prompted by greater royalty rates and gaining market share, particularly with digital TVs and microcontrollers. Furthermore, the company's promising, higher-value Cortex-A processor range, which are used in smartphones and tablets, also printed increased royalty percentages during the quarter.

Last month's results also showed ARM's order backlog in the October-December period rose 25% from the third quarter. This advance provides assurance that ARM should continue to ride out the current troubles affecting many of its peers.

The price is right?
City analysts expect earnings per share to continue rocketing higher in coming years, with growth of 28% to 19 pence predicted for 2013, and a 26% increase to 24 pence anticipated next year.

But ARM currently trades on gargantuan P/E readings of 49.4 and 39.3 for this year and next, far in excess of the forward multiple of 26.5 projected for the broader technology hardware and equipment sector.

And the firm's premium rating is underlined by price/earnings to growth (PEG) estimates of 1.8 and 1.5 for the next two years (a figure under 1 is generally considered decent value for money). ARM's share price has leapt more than 1,000% during the past five years, and current levels suggest the optimistic growth prospects are currently priced in.

Diddy dividends
ARM's commitment to stellar growth is reflected in a miserly dividend yield, projected at 0.6% and 0.7% for 2013 and 2014, respectively, and well below the 3.5% FTSE 100 average.

The tech company continues to build its yearly dividend, and projected payouts of 5.3 pence and 6.5 pence per share for this year and next are up from 4.5 pence per share for 2012. However, such amounts still lag the payments from most of the UK's other large caps by quite a distance.

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So in my opinion, the combination of a small dividend combined with an ultra-high P/E rating undermines ARM's case as a profitable ISA pick, at least for the time being.

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  • Report this Comment On March 11, 2013, at 7:04 PM, Foolme2x wrote:

    Interesting that the PE numbers you cite for the LSE traded shares are only a fraction of the PE quoted for the US traded ADRs. I've been long ARMH for more than a decade. Those who use PE as their only method to gauge valuation thought it was too expensive to buy back when I bought it, just as they do now.

    If you find a stock with consistent growth north of 20% and a PEG below 1, it is because one of two conditions exist. 1 - The overall market has bought into the idea that the end of the world is at hand (think October 1987, September 2002, March 2009), or 2 - The market believes there is something fishy with the 20% growth outlook. Neither condition appears to apply here. I don't know what PEG that ARMH should carry. In general, many of the "talking heads" on TV will tell you that a PEG of 2 is "reasonable" for a company with demonstrated and projected continued growth greater than 20%.

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