Processor architect ARM Holdings (Nasdaq: ARMH) is soaring today. The company reported a stellar fourth quarter early this morning, and the stock is up by more than 7% as a result.
Those shares have now tripled over the past year, and they're trading at a vertigo-inducing 97 times trailing earnings. Is it time to take your profits and get out of this red-hot stock?
That would be a gutsy call to make. ARM's results are not just improving, but accelerating. Based on the company's dominance in the exploding smartphone and tablet markets, ARM saw earnings per share jumping by 62% year over year, on 28% higher sales. Gross margins were always fantastic for this intellectual-property business, but they crept even higher this quarter, now sitting at 94.2%.
It's an extremely profitable business model, doing processor research, then leaving the dirty work of manufacturing and selling actual processors to a wide range of license buyers. ARM held up NVIDIA (Nasdaq: NVDA) as an early adopter of next-generation chip architectures, but the customer list ranges from chip giants Texas Instruments (NYSE: TXN) and Marvell Technology Group (Nasdaq: MRVL) to gadget designers Samsung and Apple (Nasdaq: AAPL), who also create ARM processors of their own.
Since some of these license agreements are made on a long-term basis, part of the sales are recorded as deferred revenues. That backlog just grew by 82% year-over-year on the company's balance sheet, significantly outpacing standard sales growth. In other words, growth is guaranteed to continue for at least a few more quarters.
The stock is still very richly valued, and most of the good news on the table should be priced in by now. But you'd be crazy to short a stock on this kind of rampage, and short interest is in fact very low, despite the nosebleed valuation.
A more proactive -- and sane -- anti-ARM strategy might involve investing in up-and-coming competitor MIPS Technologies (Nasdaq: MIPS) and its much more reasonable price-to-earnings ratio of 28 times trailing earnings. But 25% of that stock was sold short three weeks ago. Go figure.
Does ARM have any rocket fuel left in its tanks, or are you better off elsewhere? Discuss in the comments below.
