To say that 2014 has been a disappointing year thus far for investors in ARM (LSE: ARM) (NASDAQ: ARMH.US) would be a gross understatement. Indeed, shares in the UK technology company have fallen by 14% since the turn of the year, while the FTSE 100 is flat over the same time period. What makes the share price performance all the more surprising is that ARM released an encouraging set of results recently that showed the company is making good progress and that its business model remains sound.
Of course, a lower share price can often mean better value for money. In ARM’s case, that seems to be true and, furthermore, the company seems to have upside of 23%. Here’s why.
A Resilient Business Model
One of the key drawbacks of investing in technology companies can be that their earnings profile is very volatile. For instance, they may experience some great years, during which the bottom line expands rapidly. However, there are also likely to be some dismal years where losses are not uncommon.
ARM, though, appears to be a little different to your typical technology stock. That’s because its business model focuses on intellectual property and, specifically, on staying a step ahead of the competition when it comes to ideas and visions of how products may look and work in future. This has allowed ARM to avoid being bogged down in the challenging space of manufacturing, which has meant that the company’s profitability has remained strong in recent years. For instance, ARM has grown earnings per share (EPS) in each of the last four years, with the growth rate averaging a highly impressive 41% per annum. Meanwhile, evidence of its resilience and consistency can be seen in the fact that earnings have grown by at least 18% per year during the four year period.
Growth Potential
Although this year is set to see a slight slowdown in the company’s growth rate (ARM is forecast to post EPS growth of 10%), next year is due to be much better. Indeed, EPS is expected to rise by 23% in 2015, which is much more in keeping with the company’s historic growth rate. Furthermore, now that shares have derated somewhat, the market appears to be comfortable with the company’s current valuation, with its price to earnings (P/E) ratio being 40.8. This may sound high to many investors, but it has been far higher in recent years.
So, assuming that ARM’s P/E stays where it is, shares could be trading 23% higher this time next year, simply as a result of the company meeting its growth forecasts. This would equate to a share price of 1152p and, furthermore, there could be even more capital gain potential if ARM’s P/E ratio expands to former, higher levels.
Looking Ahead
Certainly, ARM must deliver on its growth forecasts, but with a relatively resilient business model and a strong track record of posting impressive growth numbers, ARM could prove to be a strong buy right now. With 23% upside, it could prove to be a winning investment.
