I’m in no doubt that ARM Holdings (LSE: ARM) (NASDAQ: ARMH.US) is a world-class British success story. It boasts cutting edge engineering, and has an innovative and profitable business model.
Shareholders have done well, too. If you purchased ARM shares five years ago, you are now sitting on a 696% capital gain and enjoying a 4.1% dividend yield on cost.
However, although this impressive Cambridge-based business is still growing, I rate ARM shares as a sell.
What’s the problem?
I rate ARM shares as a sell for one simple reason: I cannot imagine why any sensible investor would even consider buying them.
Let’s look at a few facts:
ARM shares currently trade on a trailing P/E of 48 times adjusted earnings. Looking ahead using brokers’ consensus forecasts, they trade on a 2013 forecast P/E of 42, and a 2014 forecast P/E of 33.
At the same time, ARM shares offer a yield for new buyers of just 0.75%.
Looking at these numbers, I just don’t see any reason to invest. There’s almost no income, and a huge amount of growth is already priced into the shares, setting them up for sharp falls if ARM disappoints the markets at any point during the next few years.
What about ARM’s new products?
ARM’s business is almost certain to continue growing over the next few years, but some of the growth areas are in much lower cost, lower margin areas, such as chips that will embedded in household appliances.
Smartphones will continue to be a key ingredient in the firm’s profits, but I think that the initial, explosive growth in this area is now slowing, even allowing for later uptake in emerging markets.
ARM’s big hope for high-margin growth is that its processors — which have very low power consumption — will make in-roads into the Intel-dominated server market. However, I’m not sure this will work, for two reasons.
Firstly, Intel has a huge incumbent presence in the market, with a global sales network, and its own range of low power consumption processors, which are fast catching up with ARM’s.
Secondly, software written for Intel chips won’t work on ARM processors without being rewritten, meaning that ARM chips can’t simply be swapped for Intel chips when servers are upgraded.
The next ARM?
ARM’s share price has risen by 615% over the last four years, making it a fantastic investment for growth investors, and I reckon that now is the right time to take profits.
Although the stock market regularly provides opportunities for outsized profits such as those which ARM investors have enjoyed, you have to know what to look for, when to buy, and when to sell.
These topics are all covered in the Motley Fool’s “Millionaire Report“, which explains how you might be able to build up a million-pound portfolio by investing in growth shares.
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> Roland does not own shares in any of the companies mentioned in this article.