Should I Buy ARM Holdings plc?

It’s time to go shopping for shares again, but where to start? Is now the time to buy ARM Holdings (LSE: ARM.L) (NASDAQ: ARMH.US)?

Coals to Newcastle, chips to Apple

More than any other stock, Cambridge-based microchip maker ARM Holdings taught me a valuable lesson about the virtue of investing for the long term. I held it, briefly, a few years ago, then sold it in a fit of impatience. It was a costly lesson, because the stock is up a stonking 1,144% in the last five years, 22 times FTSE 100 growth in that period. I was wrong to sell it then. Would it be right to buy it today?

ARM’s chips appear in an astonishing 95% of smartphones. This is great news for investors, because the stock benefits from every shade of mobile phone-related news. So when Apple struck a deal to supply its iPhone through China Mobile just before Christmas, ARM’s share price headed that day’s leaderboards. When Dixons Retail posted strong sales growth earlier in December, ARM topped the charts. When it was rumoured that Google was considering designing its own server processes, using ARM’s technology, the share price outpaced the field.

Cheap as chips

ARM chief executive Simon Segars has just predicted that Apple’s move into China and the emergence of low-cost smartphones should further drive company sales. As phones get cheaper, “billions of people” will be able to upgrade to newer models, nearly of them brimming with ARM’s chips. “That will help drive volume, which is what we are all about,” he told the Consumer Electronics Show in Las Vegas on Wednesday. But I can’t help worrying that cheap phone manufacturers will demand cheaper chips, and wonder whether that could hit margins at ARM.

It hasn’t been all good news for ARM. Last October’s Q3 update disappointed, despite a 36% rise in pre-tax profit to £92.6 million year-on-year, and a record 48 licences signed by 24 companies. The market felt more was needed to justify the recent stratospheric share price growth. It also faces tough competition from Intel, which is getting suspiciously friendly with Samsung. I wouldn’t put too much faith in that Google rumour, although it would drive the share price yet higher if it proves correct. The reason I have never bought back into ARM is that I feared its growth prospects were reflected in its soaring share price, leaving it prone to a sharp correction. I was scared of compounding my original mistake of selling ARM at the bottom, by buying it at the top. Currently priced at 71 times earnings, nearly seven times the FTSE 100 average, I remain nervous.

First do no ARM

If the world is about to be flooded with cheap smartphones, however, ARM could have further to fly. Earnings per share rose 38% in 2013, and are forecast to grow another 21% this year and 24% in 2015. The West may soon be saturated with smartphones and tablets, but emerging markets offer a massive growth opportunity. If I had held onto ARM, I would still hold it today (after banking some of my fabulous profits). But I think I have left it too late to buy back into this stock. You might pay a high price for a company making components in “cheap” products, and any fall from today’s highs could prove costly.

No investor can afford to ignore technology and telecoms. If you want to profit from This Red Hot Sector, you must read the latest Motley Fool investment report. The Motley Fool's Guide to Investing in Telecoms shows you how to value FTSE telecoms giants. To find out more, download our free report. It won't cost you a penny, so click here now.

> Harvey doesn't own any company mentioned in this article.