3-Point Checklist: Should You Buy ARM Holdings plc, Rolls-Royce Holdings PLC Or BAE Systems plc?

Which stock provides the most attractive exposure to British industry: ARM Holdings plc (LON:ARM), Rolls-Royce Holdings PLC (LON:RR) or BAE Systems plc (LON:BA)?

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Shares in Rolls-Royce Holdings (LSE: RR) rose by 3% when markets opened this morning, after the firm announced that Warren East would take over from John Rishton as chief executive at the engineering firm.

Mr East is best known to investors as the previous chief executive of ARM Holdings (LSE: ARM) (NASDAQ: ARMH.US), where he oversaw the firm’s growth into a world-leading chip design whose products are in nearly every smartphone.

ARM and Rolls both offer investors a different way to back the best of British industry. In this article I’m going to compare these two firms with a third choice, defence giant BAE Systems (LSE: BA), to see which looks the most appealing buy in today’s market.

1. Earnings growth

 

Rolls Royce

ARM Holdings

BAE Systems

5-year average adjusted eps growth

11%

22%

-1.4%

2015 forecast earnings growth

-8.6%

67%

0%

ARM is clearly the growth star here, with Rolls Royce a respectable second — historically at least — and BAE lagging behind.

Looking ahead, Rolls is expected to have a difficult year in 2015, before returning to growth, while BAE’s guidance is for earnings per share “marginally higher” than in 2014 — so I’ve assumed no growth.

2. Dividend choices

For income investors, buying shares in ARM makes no sense. The firm’s 0.7% yield is below that available on cash savings.

However, Rolls and BAE both have clear attractions:

 

Rolls Royce

ARM Holdings

BAE Systems

5-year average dividend growth

7.6%

19.3%

3.2%

2015 forecast dividend growth

3.0%

23.9%

1.8%

2015 prospective yield

2.3%

0.7%

4.1%

Rolls-Royce’s dividend has grown faster, historically, but that growth is slowing and the firm’s 2.3% yield is considerably lower than the 4.1% available from BAE. Both dividends are expected to be covered at least twice by earnings, suggesting that BAE could be the best choice for an income buyer.

3. Is the price right?

As you’d expect, there are big differences in the valuations of these three companies:

 

Rolls Royce

ARM Holdings

BAE Systems

Trailing P/E

15.9

46.7

13.3

2015 forecast P/E

17.4

39.6

13.2

Investors will be watching carefully for any changes to guidance or strategy after Mr East takes charge at Rolls Royce on 2 July. In the meantime, the firm’s valuation relies on market confidence that Rolls can return to earnings growth in 2016, although Rolls Royce’s lack of debt provide additional downside protection.

BAE, on the other hand, looks cheaper, but does have a reasonable amount of debt and a track record of sluggish growth.

Today’s best buy?

In my view, BAE is a decent income buy, but for long-term investors seeking income and capital growth, Rolls could be a better choice.

ARM remains a stock for growth investors: the firm’s valuation is demanding, but it is an exceptional quality business with strong momentum behind it.

Ultimately, it’s your call.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be considered so you should consider taking independent financial advice.

Roland Head owns shares of BAE Systems. The Motley Fool UK has recommended ARM Holdings. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Young woman working at modern office. Technical price graph and indicator, red and green candlestick chart and stock trading computer screen background.
Investing Articles

Should I invest in the FTSE 100 – or try to beat it?

Our writer has the option of investing in a FTSE 100 tracker fund. So why does he choose to buy…

Read more »

Young black woman walking in Central London for shopping
Investing Articles

£1,500 to invest in a Stocks and Shares ISA? Here’s how I’d do it

Our writer has been investing in his Stocks and Shares ISA. Here he details how he could put £1,500 in…

Read more »

One English pound placed on a graph to represent an economic down turn
Investing Articles

2 top FTSE 100 shares I’d buy before the market rebounds!

Christopher Ruane identifies a pair of FTSE 100 shares that have both tumbled in the past year and that he…

Read more »

Business development to success and FTSE 100 250 350 growth concept.
Investing Articles

Here’s why the next bull market may have already begun

The UK stock market has taken the Bank of England's interest rate hike in its stride and green shoots suggest…

Read more »

Gold medal
Investing Articles

No contest! Here’s my stock of the week

An update from this company offered some relief from the economic gloom. It's this Fool's stock of the week.

Read more »

Cogs turning against each other
Investing Articles

Scottish Mortgage shares are back on the rise: is now the time to jump onboard?

Scottish Mortgage shares have risen over 25% in the past 30 days. This Fool takes a look at why and…

Read more »

Middle-aged white man wearing glasses, staring into space over the top of his laptop in a coffee shop
Investing Articles

Why do Lloyds shares seem so cheap?

Lloyds shares have been losing ground and now look cheap on some valuations. So why has our writer removed the…

Read more »

Investing Articles

How to invest in shares to help beat inflation

Soaring prices could well outstrip our investing returns this year. I think it's more important to find shares to beat…

Read more »