A Closer Look at ARM Holdings' Dividend Potential

LONDON -- Dividend income accounts for around two-thirds of total returns, the actual rate of return taking into account both capital and income appreciation. Given that share prices are often volatile and unpredictable, the potential for plump dividends can give shareholders much-needed peace of mind for decent returns.

I am currently looking at the dividend prospects of ARM Holdings  (LSE: ARM  ) (NASDAQ: ARMH  ) and assessing whether the company is an appetizing pick for income investors.

How does ARM Holdings' dividend history stack up?

 Metric

2009

2010

2011

2012

FY dividend per share

2.42 pence

2.9 pence

3.48 pence

4.5 pence

DPS growth

10.00%

19.80%

20.00%

29.30%

Dividend cover

2.3 times

3.2 times

3.6 times

3.3 times

Source: ARM Holdings company accounts.

ARM Holdings has a very decent record of growing the dividend in recent years, even posting double-digit expansion in 2009 despite a slight dip in earnings. The company has been able to turbocharge the payout since then as earnings have exploded, with last year's growth almost triple that of 2009.

Dividend cover has remained substantially in excess of the generally regarded benchmark of 2 times forward earnings, mainly due to the company allocating substantial amounts of capital into research and development to boost its product pipeline and ensure excellent earnings growth prospects.

What are ARM Holdings' dividends expected to do?

 Metric

2013

2014

FY dividend per share

5.6 pence

6.6 pence

DPS growth

24.40%

17.90%

Dividend cover

3.7 times

3.8 times

Dividend yield

0.50%

0.60%

Source: Digital Look.

ARM Holdings announced in last month's interims that revenue leapt 28% in January-March to 170.3 million pounds, pushing pre-tax profit an impressive 44% higher from the corresponding 2012 period to 89.4 million pounds. The company generates turnover from designing and licensing IP for semiconductors, and solid demand for its next-gen smartphone and tablet PC technology helped to drive performance.

Brokers expect earnings to rise 36% this year and 24% in 2014, helping to underpin meaty dividend growth, even if consensus expects the growth in shareholder payouts to moderate from last year.

Additionally, the firm is an excellent cash generator, which should also underpin its ultra-progressive dividend policy. Net cash stood at more than 520 million pounds as at the end of December 2012 versus around 478 million pounds three months earlier.

How do ARM Holdings' dividend prospects rate against the competition?

 

Prospective Dividend Yield

Prospective P/E Ratio

Technology hardware and equipment

2.40%

22.5

FTSE 100

3.20%

15.5

Source: Digital Look.

ARM Holdings currently changes hands on a P/E rating of 52.4 for 2013, steaming ahead of the valuation of its sector peers despite a far-less lucrative dividend yield. It also lags its fellow FTSE 100 constituents in both respects, and the company's low yield makes it an unattractive income pick, in my opinion.

Broadly speaking, although I am tipping earnings to keep heading substantially higher, I believe that ARM Holdings is severely overpriced at current levels. The company's exceptional track record of innovation, coupled with ability to gain market share, has pushed the share prices relentlessly skywards.

But fears over waning semiconductor demand and rising competition from the likes of industry giant Intel -- whose growing stable of customers includes Lenovo and Motorola -- leaves ARM Holdings at jeopardy of a heavy share price correction.

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