Is Now The Time To Buy ARM Holdings?

Published in Company Comment on 24 December 2012

Should you buy ARM Holdings (LSE: ARM) today?

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

So right now I am trawling through the FTSE 100 (UKX) and giving my verdict on every member of the blue-chip index. Simply put, I'm hoping to pinpoint the very best buying opportunities in today's uncertain market.

Today I am looking at ARM Holdings (LSE: ARM) (NASDAQ: ARMH.US) to determine whether you should consider buying the shares at 738p.

I am assessing each company on several ratios:

Price/Earnings (P/E): Does the share look good value when compared against its competitors?

Price Earnings Growth (PEG): Does the share look good value factoring in predicted growth?

Yield: Does the share provide a solid income for investors?

Dividend Cover: Is the dividend sustainable?

So let's look at the numbers:

StockPrice3-yr EPS growthProjected P/EPEGYield3-yr dividend growthDividend cover
ARM Holdings738p127%523.30.5%40%3.5

The consensus analyst estimate for next year's earnings per share is 14.4p (16 % growth) and dividend per share is 4p (14% growth).

Trading on a projected P/E of 52, ARM appears slightly more expensive than its peers in the Technology Hardware & Equipment sector, who are currently trading on an average P/E of around 49. ARM's P/E and double-digit growth rate give a PEG ratio of around 3.3, which implies the share price is very expensive for the near-term earnings growth the firm is expected to produce.

Offering a 0.5% yield, the dividend is about half of the Technology Hardware & Equipment sector average. However, ARM has a three-year compounded dividend growth rate of 40%, implying the payout could soon catch up to that of its peers.

Indeed, the dividend is three-times covered, giving ARM plenty room for further payout growth. ARM is focused on a progressive dividend policy, with this year's interim dividend up 20% from last year.

ARM looks expensive. Are the shares it worth it?

I do not like buying expensive technology stocks and ARM seems to be one of these. Although ARM is trading below the sector average P/E ratio, its PEG ratio is sky high, leading me to believe the stock is overpriced.

Anyway, so far this year ARM has seen strong growth. The company's third-quarter results showed group revenue up 20% and profits up 22%. The revenue growth was largely driven through processor royalty sales, which advanced 27% over the year.

I believe ARM has hedged its bets, with the company designing processing units for all of the major smart-phone manufacturers. This diversification has given the company multiple income streams, protecting the firm from the loss of a single contract.

However, ARM could be facing increasing competition in the future as Intel continues to attack ARM's market share. I believe there is also speculation about a takeover of ARM -- historically this has been a prospect but many analysts now doubt this due to ARM's high valuation.

Although most analysts are bullish on ARM, I believe the high valuation leaves little room for disappointment and even a slight slowdown in revenue growth could be very painful for the stock. So overall, based on the high valuation and low yield, I believe now does not look to be a good time to buy ARM Holdings at 738p.

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

> Rupert does not own any share mentioned in this article.

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Comments

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UncleEbenezer 25 Dec 2012 , 1:23pm

I don't see anything much to fear from Intel: rather closer to the reverse (though that appears now to be priced in).

The more interesting competition will come if IMG's stewardship succeeds in reviving MIPS's fortunes. That has a mountain to climb before it encroaches on ARM's sexy markets in and around the android&apple worlds, but is one to watch where no such standard platform is dominant.

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