Sorry!! The article you are trying to read is not available now.
Thank you very much;
you're only a step away from
downloading your reports.

Is ARM Strong Enough to Pull in Investors?


The stock is pricey and its valuations are high, but the company cites huge growth potential.

Last weekend, Barron's attempted to wet our appetite with a laudatory article about ARM Holdings (ARMH). ARM is a great company that has been flying under the radar for years. Its microprocessor cores have enabled their licensees to develop some absolutely fabulous products, particularly for mobile applications in which performance and power are always a trade-off.

However, great companies don't always make great investments.

As you can see in the graph below, ARM's stock has had a great year, up more than 130%. It easily beats its peers in the Philadelphia Semiconductor Index (SOX) as well as the broader averages. But despite the huge run, that alone doesn't mean you should avoid it.

Investors need to look at valuation which, in this case, is fairly hefty as well. As you can see in the table below, it isn't a cheap stock. There's no rhyme or reason to the names I selected for comparison purposes but on price-to-trailing-sales, price-to-forward-earnings, and price-to-earning-to-expected-growth-rate, the premiums are pretty big.

Here again, high valuations alone shouldn't be the sole deterrent if your risk tolerance is high and you're used to investing in growth stocks. But what it does tell you is that maybe you need to keep it on your radar and wait for the inevitable periods when the market says all stocks are going to zero. Sure, we'd all like to have bought last March but there were some other pull-backs along the way last year as well.

The ARM bulls out there will argue that the stock's valuation is simply reflecting the growth opportunity in front of the company. But that's the tricky part of the investment equation. What is the real opportunity?

Anyone observing the cell-phone business over the last five years or so knows that it's been huge for ARM's fundamentals. Since 2004, the industry's unit growth is about 75%, despite last year's "subdued" number at about 1.1 billion handsets. That's one very large addressable market for ARM's products and the company acknowledges having 85% to 95% unit market share. Roughly one-third of ARM's revenue is from the royalties in mobile devices. But as an investor, you have to be asking yourself, "Is this going to continue in order to support that valuation?" ARM thinks so!

One of the growth opportunities cited on its most recent conference call is in smartphones. The company expects to see unit growth of about 250% over the next five years such that the category will represent 50% of all units in 2014. That's a pretty aggressive assumption, but who knows? ARM even expects about half the people on the planet to buy a cell phone that year. Who'd a thunk it?

The other really big driver of growth for ARM is expected to be the microcontroller unit (MCU) market. The company estimates that this 4.5 billion unit market will double to 9.0 billion units in 2014. While that may be true, the concern from an investment perspective has more to do with the impact on ARM fundamentals.

Today's microcontroller units cost around $3.00 on average versus about $20 per unit for parts going into a cell phone. It would appear that ARM's royalties per unit will have to be quite low in order for the economics to work for the MCU OEM. But that lower revenue per unit will create a drag on ARM's top-line growth rate.

Those are just a couple of considerations to ponder before you jump into any stock but especially true when one is as pricy as this one.

Minyanville's stock portfolio, FlexFolio by Quint Tatro, is beating the S&P 500 by 26% since inception. With a 14 day FREE trial you'll get trade alerts, interactive strategy sessions and access to the full portfolio. Learn more.
< Previous
  • 1
Next >
No positions in stocks mentioned.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

Copyright 2011 Minyanville Media, Inc. All Rights Reserved.
Featured Videos