ARM Holdings (LSE: ARM) (NASDAQ: ARMH.US) is the sort of company that has confounded many investors. The company is far too expensive, the share price will fall, we all say.
Yet the share just keeps rising, as the company rides the wave of new devices such as smartphones and tablets. This is a trend that has driven the share price higher and higher.
Computing’s grand divergence
The evolution of computer chips had a grand divergence in the 1990s. ARM’s bright idea was that computer chips could be designed with a reduced and simplified set of instructions, rather than the complex instruction sets of chips designed by companies such as Intel.
People may not have realised at the time, but this was the computing equivalent of mammals evolving from dinosaurs. Intel chips were ideally suited to PCs, where their power and speed outweighed the disadvantages of their high energy consumption and the heat they produced.
But when Steve Jobs launched the iPhone and the iPad, suddenly Intel suddenly found themselves in a cul-de-sac, while ARM had an open highway of possibilities. When energy consumption and temperature control are at a premium, ARM’s chips win hands down.
A booming market
ARM has dominated the market for smartphone and tablet microprocessors, and as this market has boomed, so ARM’s share price has surged. But there is room for much further growth. More and more people in developed markets are trading up to smartphones. But the greatest potential for growth is in emerging markets, where uptake of smart phones has as yet been low. As high-speed mobile networks are built around the world, so there will be a flood of customers to smart phones.
There is also the boom in tablets. More and more people are moving from PCs to tablets, and there is also the as yet untapped business market. Once companies start buying tablets instead of computers, then the tablet market will grow further.
Regular readers will know that I gave very similar reasons for investing in Apple earlier this year. The difference is: while Apple has fearsome competition from companies such as Samsung and HTC, ARM currently dominates the mobile microprocessor market. Intel’s market share is negligible.
A future grand convergence?
What’s more, a version of Microsoft’s Windows now also runs on ARM chips, so I expect ARM to eventually muscle in on the computer market as well. I foresee a future where computers are lighter, slimmer and more portable: rather more like their tablet and smartphone cousins.
This could bring about an almighty battle between ARM and Intel — and, personally, I quite fancy the UK company’s chances.
Having said all this, the shares have already risen a lot, and the company now is very expensive. The time to buy in was actually a year ago. Even though I am confident the company will grow further, I expect the share price to be range-bound for quite a while, as profits catch up with expectations.
Any major move up or down will depend upon whether ARM successfully breaks into the computer market, or whether Intel has a successful foray into mobile computing.
So I won’t be buying, but I will watch from the sidelines with interest.
Foolish final thought
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> Prabhat does not own any of the shares mentioned in this article. The Motley Fool owns shares in Apple.
