The prospects of ARM Holdings plc (LON: ARM) don't quite justify the valuation.
A version of this article was published originally on Fool.com.
WASHINGTON, DC -- While ARM Holdings (LSE: ARM) (NASDAQ: ARMH.US) indeed plays a critical role in the mobile future of computing, the company's current valuation seems a little overly optimistic.
Even though ARM's place in the value chain is unique, I've questioned the company's ability to effectively monetise its microchip architecture designs, which led me to sell my own shares nearly a year ago. Since getting out, shares have continued to rally and are up nearly 60% in the past nine months.
ARMH data by YCharts.
So, have ARM's shares run ahead of themselves?
In fact, the only thing that knocked ARM back from that high was a downgrade form Morgan Stanley on valuation concerns. That wasn't the only broker expressing concern, and other sceptics include Benchmark (to hold) and Bernstein Research (to underperform). As sceptical as I was last April about ARM, I'm even more doubtful now.
On the one hand, royalty-bearing unit shipments continue to soar along with adoption of smartphones and tablets, although the average royalty rate per unit has been on a steady decline over the years.
Source: ARM.
This chart is separated between prior years and ARM's 2012 results through to the third quarter. The company is on track to increase royalty units again in 2012 if it can collect royalties on at least another 1.7 billion chips.
At the same time, the shares now trade at nearly 80 times earnings and 21 times sales, yet revenue only grew by 18% during the last quarter.
Instead of investing in ARM, its licensees create more value within the chain and therefore garner more profits. That's precisely why I own shares of both Apple and Qualcomm, two of the few companies that license an architecture instruction set in order to create custom ARM-compatible processing cores (Swift and Krait, respectively).
ARM's monstrous run over the past year has it now priced to perfection, and in this case even its solid prospects don't quite justify the valuation. That's why I'm giving ARM's stock an 'underperform' call today.
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Evan owns shares in Apple and Qualcomm.
