ARM Holdings: Buy, Sell, or Hold?

LONDON -- I'm always searching for shares that can help ordinary investors like you make money from the stock market.

Right now I am trawling through the FTSE 100 and giving my verdict on every member of the blue-chip index.

I hope to pinpoint the very best buying opportunities in today's uncertain market, as well as highlight those shares I feel you should hold... and those I feel you should sell!

I'm assessing every share on five different measures. Here's what I'm looking for in each company:

1. Financial strength: Low levels of debt and other liabilities;

2. Profitability: Consistent earnings and high profit margins;

3. Management: Competent executives creating shareholder value;

4. Long-term prospects: A solid competitive position and respectable growth prospects.

5. Valuation: An underrated share price.

A look at ARM
Today I'm evaluating ARM Holdings  (LSE: ARM  ) (NASDAQ: ARMH  ) , the world's leading semiconductor intellectual property supplier, which currently trades at 1,066 pence. Here are my thoughts:

1. Financial strength: ARM is in excellent financial health, with a net cash position of 381 million pounds and over 1 billion pounds of free cash flow generated during the last five years.

2. Profitability: ARM has grown rapidly over the past 10 years. Revenues have increased more than three-fold and operating profits 11-fold, while adjusted-earnings per share have grown nine times from 1.7 pence in 2003 to 14.5 pence in 2012 and dividends per share eight times from 0.6 pence in 2003 to 4.5 pence in 2012. Operating margin has ranged from 15%-20% for most of the decade and has risen the last few years from 26% in 2010 to 30% in 2011 to 36% in 2012. The 10-year average return on capital employed has been excellent at 36%.

3. Management: Warren East has been ARM's CEO since 2001, successfully steering ARM from a small stalwart earlier in the decade to the dominant mobile-chip maker it is today. He recently announced his retirement and Simon Segars, the company's president, will take over on July 1.

4. Long-term prospects: Instead of manufacturing its own CPUs, ARM develops processor and other technology designs that it licenses to other companies for a one-off licence fee while also receiving royalty payments for every ARM-based chip sold by the licencee. ARM's chips go into a wide range of mobile, consumer and embedded products such as mobile handsets, tablets, laptops, digital cameras and modems. Due to its low-power and battery-saving features, it is the chip of choice for a majority of mobile devices. Its designs are used by companies like AppleNVIDIAMicrosoft, and Qualcomm. ARM has 95% of the market share in mobile phones, 35% in networking, 45% in digital TVs, and 18% in microcontrollers. Last year, the company sold around 9 billion ARM-based processor chips, accounting for 32% of the total market. Its closest rival, Intel, had 16%.

Moreover, ARM is primed for more growth in the coming years. Smartphones can earn the company 5-10 times more royalties per chip and the market is expected to double by 2016, while tablets are still in their infancy and are expected to overtake the PC as the preferred computing device of choice for consumers in the future. By 2015, the company expects to control about 50% of the mobile PC market: laptops, tablets, and netbooks.

Still, ARM faces some competition with Intel, which has already started developing its own low-powered chip architecture. However, how much of a threat Intel is to ARM remains to be seen.

5. Valuation: Shares are trading at a forward price-to-earnings ratio of 56, a significant premium to its 10-year average P/E of 34. However, its PEG ratio of 1.05 compares well with the sector PEG of 0.9.

My verdict on ARM
There is no question ARM is a great company and it is likely to continue growing at an impressive rate the next few years. However, high expectations are already built in its share price and, at such lofty valuations, there is almost no room for error. Also, a rival such as Intel, with its size and resources, could pose a credible threat to ARM's foothold in the smartphone and tablet market. Therefore, it would be more prudent to wait for a better opportunity to buy this excellent company at more sensible valuations.

So overall, I believe ARM at 1,066 pence looks like a hold.

More FTSE opportunities
Although I feel ARM is a hold right now, I am more positive on the FTSE shares highlighted in "8 Dividend Plays Held By Britain's Super Investor." This exclusive report reveals the favorite income stocks owned by Neil Woodford -- the City legend whose High Income fund turned 10,000 pounds into 193,000 pounds during the 25 years to 2012.

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In the meantime, please stay tuned for my next verdict on a FTSE 100 share.


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  • Report this Comment On May 14, 2013, at 3:30 PM, Gainster wrote:

    They have a trailing P/E of 90, so stockholders are in for a schock if EPS falls short of expectations, aka Intel conquers a part of their most profitable market, the mobile market.

    Two top executives at ARM just sold all of their shares, which should be a strong hint.

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