While most investors would say that ARM (LSE: ARM) (NASDAQ: ARMH.US) is a more exciting stock to own than British American Tobacco (LSE: BATS) (NYSE: BTI.US), this may not be the case. Certainly, ARM is at the centre of technological advancement in terms of the intellectual property for smartphones and all sorts of other gadgets and technological items. However, British American Tobacco could be on the brink of a very prosperous and, therefore, exciting period of its own. As such, I’d rather buy the latter than the former – here’s why.
E-Cigarettes
While e-cigarettes have been around for many years in various guises, they have never really caught on. Today, however, they are extremely popular and seem to be the future of the tobacco industry, since they are apparently far less harmful and, at the moment, are cheaper than their tobacco alternative.
So, it is extremely encouraging that British American Tobacco is at the forefront of the e-cigarette industry, via its Vype brand. It was launched a couple of years ago and its results thus far have been encouraging. However, even if Vype fails to dominate the e-cigarette industry moving forward, British American Tobacco has such strong cash flow that it can afford to engage in M&A activity so as to position itself favourably for the long term. For example, over the last five years British American Tobacco’s free cash flow has averaged £3.9bn per annum, which provides evidence of its vast financial flexibility.
Mature Versus Juvenile
Clearly, ARM is a much newer company than British American Tobacco and operates in a market that is far younger than tobacco, and which offers the scope for far higher growth rates. However, in recent years ARM’s growth rate has slowed down somewhat as it has become a more mature business that may be unable to sustain its current rate of growth in the long run.
In addition, ARM’s industry has its pitfalls. While British American Tobacco is one of the dominant players in an industry that is almost impossible to enter, ARM, on the other hand, could find itself outmanoeuvred by new rivals or even by an unexpected shift in industry dynamics that leads to disappointing sales moving forward. As such, British American Tobacco’s results are likely to be far more stable than those of ARM in the long run, which is an important consideration for long term investors.
Valuation
Although ARM is expected to grow its bottom line by 68% this year and by a further 20% next year, it still offers excellent value for money at the present time. For example, it has a price to earnings growth (PEG) ratio of just 0.6, which is highly appealing. Meanwhile, British American Tobacco has a price to earnings (P/E) ratio of 17.4 which, when you take into account its excellent track record, future potential and consistency, seems like a very appealing price to pay.
However, despite both stocks being attractive at the present time, my money’s still on British American Tobacco to be the stronger performer in the long run. It mixes great value, strong growth potential from e-cigarettes and a stability that is very difficult to match and, as such, I’d rather buy a slice of it over ARM.