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Why I'm Buying Shares of ARM Holdings plc

By Ashraf Eassa - Feb 10, 2016 at 4:30PM

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This semiconductor IP company is too high quality to ignore.

Shares of semiconductor IP vendor ARM Holdings (ARMH) are now trading at around $39 as of a recent check of the share price. The stock had already been hammered going into its earnings report seemingly as a result of the broad weakness in the semiconductor industry that appears to be due to a slowdown in smartphone chip sales.

That being said, even though things are looking pretty rough for the processor designer in the near term, I believe that the company's long-term future is actually quite bright. As a result, once I am able to do so in compliance with The Motley Fool's trading policy, I plan to snatch up shares of ARM Holdings. Here's why.

ARM is very well positioned to profit from smartphones
Although anything related to smartphones seems to be out of favor right now, I continue to be bullish on the overall market for such devices over the long term. The smartphone market should continue to grow out in time, although that growth rate will naturally be much lower than it had been during the early innings of the smartphone boom.

More importantly, though, even as the smartphone market cools off, ARM seems to be in a great position to continue to increase its content share per device through continued proliferation of its physical IP, graphics IP (ARM claims that in the last quarter its Mali graphics processors "became the industry's highest-shipping GPU architecture"), and more.

According to its earnings presentation, about 50% of the world's smartphones contain a 64-bit ARM processor and about 40% contained ARM's graphics processors.

Given that 64-bit ARM processors generally command higher royalty rates than comparable 32-bit processors, ARM should be well positioned to grow per-processor royalty rates as the market continues to shift to 64-bit ARM processors. I also see ARM potentially increasing its share in mobile graphics from here as well, particularly as its main competitor faces significant difficulties.

ARM has a bright future outside of smartphones as well
In ARM's most recent earnings presentation, the company also described some of the other market opportunities open to it, ranging from automotive processors, "embedded intelligence," networking infrastructure, and even server processors.

The total addressable markets for these markets are quite large, although ARM only collects a small percentage of the selling prices of these chips.

Even though I would be very cautious on buying a major share gain story in servers (given that Intel's (INTC 0.64%) server chip business is seemingly impenetrable), ARM and its partners have so many large markets to go after that it's hard to imagine that it'll have trouble growing its non-mobile revenues in the coming years.

The stock isn't super cheap, but it's cheap enough
I don't expect that a company like ARM Holdings will trade at what would generally be viewed as "value stock" valuations anytime soon; this is a high-quality company with a business model that minimizes competitive threats and maximizes earnings leverage.

The stock currently trades for just under 25 times projected earnings per ADR for the fiscal year ending in Dec. 2016. That's not value-stock territory, but for a business with an effective monopoly in its core business (smartphone processors) and with many growth opportunities ahead of it, I can't help but be tempted to start a fairly significant position in this stock.

Ashraf Eassa owns shares of Intel and intends to purchase shares of ARM Holdings as soon as The Motley Fool's trading policy permits. The Motley Fool recommends Intel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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