Today I am looking at why I believe ARM Holdings (LSE: ARM) (NASDAQ: ARMH.US) is a particularly risky stock selection.
Weakening markets hang heavily
At face value ARM Holdings put in yet another blockbuster performance last year. Revenues advanced almost a quarter to £714.6m, pushing pre-tax profit 32% higher to £364m.
Although the firm’s place at the coalface of microchip innovation has made it the darling of tech giants such as Samsung and Apple, signs of rising weakness in the critical mobile phone and tablet PC markets is casting doubts over whether the firm can keep this momentum going.
Indeed, ARM Holdings noted that “slower sales of chips for high-end smartphones in the second half of the year” weighed on its 2013 results. And although the firm is diversifying into new areas such as servers to mitigate these concerns, ARM Holdings will be entering a market already dominated by big-name players such as Intel.
Earnings at risk of hefty deceleration
Indeed, fears of slowing phone demand growing steadily is expected to weigh on ARM Holdings’ stratospheric growth performance of recent years — earnings have expanded at a compound annual growth rate of almost a third since 2010. By comparison, earnings are expected to rise at a more modest 16% in 2014 and 24% next year, according to City analysts.
Although this would ordinarily represent a very decent return, in my opinion the chipbuilder’s huge P/E multiples suggest that such growth is already priced in. Indeed, readings of 40.1 and 32.2 for 2014 and 2015 correspondingly light years away from the widely-regarded value benchmark of 10 times.
Should signs of deteriorating end markets like smartphones continue, ARM Holdings could be in danger of a substantial share price crash.
Diddly dividend yields
Of course, tech specialists have never proven a happy hunting ground for investors looking for solid income flows, the requirement for vast sums to be ploughed into R&D reducing the potential for juicy shareholder rewards. But even compared with the competition, ARM Holdings offers nothing more than scant dividend prospects.
The company has made a big deal of raising investor payments recently, having lifted the dividend 27% in 2013 to 5.7p per share. But even with further advances expected — City brokers anticipate dividends rising to 6.7p and 8.3p in 2014 and 2015 respectively — such projections only create yields of 0.7% and 0.9%. These figures tally up very poorly with a forward average of 2.1% for the complete technology hardware and equipment sector.
