MENU

Why ARM Holdings plc Is A Bad Share For Novice Investors

Yesterday I took a look at a share that I think is just the kind of thing for novice investors, though it may not be an obvious choice at first sight.

Today I’m examining one that is more likely to have caught the eye of beginners, but which I think they should steer clear of.

I’m talking of top chip designer ARM Holdings (LSE: ARM) (NASDAQ: ARMH.US), whose share price has multiplied eight-fold over the past five years. Now why wouldn’t you want a piece of that?

What it does

ARM is in a relatively simple business — conceptually anyway, even if it’s technically fiendishly difficult. It designs chips for mobile computing devices, with its designs powering iPhones, iPads and the like. And it’s clever enough not to even have to make them itself, but licenses its designs for others to fabricate.

It’s also a very well-managed company, which is another thing that I think novices should be looking for.

So why not?

But much as many newcomers are attracted to the idea of high-flying growth shares, the reality is that they are very risky. Remember the eight-bagger? Well, if you’d bought ARM shares back at their peak in early 2000, your investment would have crashed to almost nothing and it would have taken you more than 12 years just to break even.And even looking back over just this summer, if you’d bought at May’s peak you’d have been 30% down just a month later. Discouraged? I bet you would have been.

Impossible to value

It’s pretty much impossible to objectively value a share like ARM. The shares currently command a price of nearly 50 times forecast earnings, and earlier in the year that figure was even higher. The average FTSE 100 share is valued at just 14 times earnings, so ARM’s profits would need to more than triple to justify that.

Now, that might happen, and today’s valuation might be fine — I really don’t know. But there’s a lot of cash riding on the expectation, and as soon as a set of results comes in that doesn’t quite reach the heights people want, the chances are the price will slump. It’s happened to every growth share I’ve ever watched, including some I’ve bought, and I expect it to happen to ARM, too.

Transition

ARM’s markets will one day mature, its profit growth will slow, and it’ll start paying more out as dividends — the yield currently stands at just 0.6%. But that transition is likely to be painful, as the wheels come off the never-ending-growth story.

You might do well with a share like ARM — in fact, some have done very well. But I reckon the uncertainty and the risk should put this kind of investment off the novice’s radar.

Finally, if you want an idea for a share that I think really is worth considering for novices, check out the Motley Fool’s Top Income Share report. I won’t tell you what it is, but I’ll give you a clue. It’s not remotely involved in high-growth technology, and it pays dividends — there’s an expected yield of better than 5.5%!

If you want to know more, click here to get your free copy today.

> Alan does not own any shares mentioned in this article.