The sale of ARM Holdings (LSE: ARM) to Japan’s Softbank for £24bn has divided opinion. Some point to the positive message it sends about British businesses post-referendum. Others, including ARM’s co-founder, mourned the loss of our brightest stars to an overseas buyer who has understandably taken advantage of the drop in sterling to capture the UK’s one remaining global technology company.
Most shareholders will be delighted with Monday’s 40% rise in the share price, of course. As an admirer of ARM but never an investor, I’m after some learning points from this development.
As a general rule, the idea that investors should avoid overpaying for stocks while also avoiding value traps makes sense. The point of investing is selling something on for more than you originally paid for it. The more you paid, the less profit (if any) you’ll make. This is easier in theory than in practice, especially when looking at growth companies where potential is matched by what appear to be sky-high valuations.
A quick scan of ARM’s financial history, however, would show that its high asking price has been justified. Its solid balance sheet, high returns on capital employed, consistent earnings growth and rapid dividend increases are indications of just how great a business Softbank has acquired.
Not every share on a low P/E will turn into a winner and not every share on a high P/E is doomed to disappoint. This makes it more important than ever to thoroughly research companies to check whether the valuation is justified. If a share screams quality, it may be worth paying that bit extra.
Don’t time the market
Trying to predict the short term movements of an index or a particular share is difficult (some would say impossible) and waiting for shares to get ‘that little bit cheaper’ can backfire. I speak from experience.
Last August, ARM’s shares dropped to 864p on fears surrounding a slowdown in China’s economy. It’s price-to-earnings (P/E) ratio dropped to its lowest for some years. Sensing they might drop even further, however, I held off. China recovered, as did ARM’s share price. Sometimes, as Warren Buffett would say, it pays to buy “a wonderful company at a fair price” than assume it will ever drop to bargain basement levels. Lesson learned.
On a related note, even if I’d invested when last writing about the company in May, I would still have achieved a 71% return. Supplementary lesson? Shares can always go higher.
No losers here
No one likes to lose money. One of the most interesting facts surrounding our financial behaviour is the finding that this aversion is so powerful we’ll usually choose to avoid a loss over securing a gain. This is why some traders often struggle to cut their losses.
As investors focused on building wealth long term, we should remember another of Mr Buffet’s famous sayings when reflecting on missed opportunities: “Rule No.1 is never lose money. Rule No.2 is never forget rule number one.”
The fact that we’re more averse to taking a loss should be used to our advantage. If you’re ruminating over your decision not to invest in ARM, we should remember that not losing money through poor stock picking is often better than failing to invest in that golden share. It’s a simple fact, easily forgotten.
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Paul Summers has no position in any shares mentioned. 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.