Is ARM Holdings plc Still A Buy After The 2013 FTSE Bull Run?

2013 has been the year in which even the most hardened stock market bears have admitted that we’re in a five-year bull market — and it’s not over yet.

Although the FTSE 100 has slipped back from the five-year high of 6,875 it reached in May, it is still up 8% this year, and is 52% higher than it was five years ago. As Christmas approaches, I’ve been asking whether popular stocks like ARM Holdings (LSE: ARM) (NASDAQ: ARMH.US) still offer good value, after five years of market gains.

Back to basics

ARM Holdings share price has gained 22% this year, leaving it 1,036% higher than it was in December 2008.

However, billionaire investor Warren Buffett says that one of the most important lessons he learned from value investing pioneer Ben Graham, is that “price is what you pay, value is what you get”.

As potential buyers of ARM, we need to decide whether the firm’s shares offer new buyers any value, or whether they are likely to crash at the first sign of any slowdown in the firm’s growth. Here’s how ARM looks, based on its performance over the last 12 months:

Ratio Value
Trailing twelve month P/E 52.8
Trailing dividend yield 0.5%
Operating margin 36.0%
Net gearing -50%
Price to book ratio 10.2

Don’t get me wrong: ARM is a fantastic company, that should be a model for more British businesses, but it’s worth pointing out that despite its £13bn market cap, it only generated £160m of profits in 2012.

Although ARM’s balance sheet is very strong, with no debt and £670m of net cash, that’s an awful lot of jam tomorrow. Given ARM’s trailing P/E of 52.8, and its paltry 0.5% yield, I cannot see a good reason to buy ARM shares at the moment.

Double-digit growth in 2014?

ARM’s trailing-twelve month earnings per share of 19.4p suggest that it will have no problem delivering on 2013 consensus forecast earnings of 20.9p per share. Analysts are bullish on 2014, too, as the figures below show:

ARM Holdings 2014 Forecast Value
2014 forecast P/E 40.1
2014 forecast yield 0.7%
2014 forecast earnings growth 22%
P/E  to earnings growth (PEG) ratio 2.0

I wouldn’t be at all surprised if ARM hits or even exceeds its earnings targets next year, but this growth trajectory is unlikely to last forever, and when it ends, I fear the resulting losses for recent buyers of ARM shares could be large.

For example, if ARM shares fell so that they traded on a P/E of 25, based on 2014 forecast earnings, its share price would fall by 37% to 637p. That’s too much of a risk for me, I’m afraid.

Finding the next ARM

The 1,036% rise enjoyed by savvy ARM shareholders over the last five years has created a number of millionaires. However, ARM is unlikely to ever deliver another 1,000% increase -- it's just too big.

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> Roland does not own shares in ARM Holdings.