Telecoms giant Vodafone (LSE: VOD) and tech champion ARM (LSE: ARM) are among the most highly-rated stocks in the FTSE 100.
At a share price of 225p, Vodafone trades on 47 times forecast earnings for its financial year ending March 2016, while buyers of ARM at 1,005p are paying 33 times expected earnings for the year ended December 2015.
These are growth-company ratings. But can Vodafone and ARM deliver the growth to justify them, and drive strong returns for investors?
Vodafone
Vodafone is coming to the end of a massive two-year investment programme for future growth. Capex for 2014/15 was £9.2bn, and by the end of 2015/16 (March) the company will have invested a further £8.5bn to £9bn.
The investment isn’t expected to produce growth this year, with revenue forecast to decline by 3.4% and earnings by 14%. However, for 2016/17 top-line growth of 2% is forecast, with earnings rising 21% on the back of the one-off benefit of a return to normal annual capex. The fruit of Vodafone’s heavy investment is forecast to really start paying off in 2017/18, when organic earnings growth of 18% is pencilled-in.
If forecasts are on the button, the P/E will have fallen from the current 47 to 33 in two years’ time, if the share price doesn’t change. That doesn’t seem a particularly attractive proposition, when you consider that ARM’s P/E is 33 today.
I suspect Vodafone’s shares are as high as they are, partly because of the company’s attractive dividend: the yield is over 5% at the current share price. The market may also be pricing-in the possibility of a bid for the company or potential M&A activity to drive earnings growth at a faster rate than currently projected.
However, as things stand, I don’t see the combination of Vodafone’s P/E and earnings growth driving a large increase in the share price over the next couple of years, although investors should benefit from a decent income.
ARM
Microprocessor designer ARM has been a top growth blue chip for some time now, having enjoyed a strong tailwind from the smartphone revolution. Analysts are expecting the company to post revenue and earnings growth of over 20% when it announces its 2015 results next week.
However, the City experts are predicting that top-line and bottom-line growth will moderate to mid-teens increases for both 2016 and 2017. On these forecasts, the current P/E of 33 falls to 26 in two years’ time, again if the share price doesn’t change.
I’m optimistic that ARM’s performance will drive strong returns for investors. In past years analysts have regularly found it necessary to upgrade their forecasts as the year progresses. And even then, the company has often gone on to beat the updated consensus.
With its strong and broadening network of partners, and its technology being deployed in an increasingly diverse range of products and markets (including the ubiquitous sensors that will form the Internet of Things), I expect ARM’s earnings to continue to surprise on the upside. And I see the stock as very buyable at current levels.