2014 ISA Essentials: Fast-Growing ARM Holdings plc

Among the FTSE 100 companies, ARM Holdings (LSE: ARM) (NASDAQ: ARMH.US) strikes me as having the greatest potential to boost ISA capital gains over the medium to long term.

Robust earnings’ growth

You can’t argue with ARM’s growth figures. Earnings per share rose by 71% in 2010, by 36% in 2011, 18% in 2012 and 40% in 2014. So what? Well, the ‘what’ for investors is that a rocketing share price accompanied the upward trajectory of earnings, moving from about 200p to today’s 1,029p. That’s a 414% uplift that you’d want to make sure was captured within an ISA wrapper so that the taxman doesn’t come knocking for capital-gains tax.

Right place, right time

ARM has secured itself a strongly defended economic position at the heart of today’s fast-moving semi-conductor industry, which is driven by the mass-consumer appetite for digital communications devices. The firm licenses its technology to leading semiconductor manufacturers who incorporate ARM’s chip designs alongside their own technology to create smart, energy-efficient chips suitable for modern electronic devices such as smart phones.

Demand for ARM’s high-performance, low-power technology offering is increasing thanks to the expanding popularity of inter-device connectivity. Margins are high and the growth-outlook is robust. So, the firm operates in a strong market and has a durable position within that market, which manifests in meaty margins and persistent double-digit earnings growth.

Accommodating a high valuation

However, after such a good run, it pays to be cautious, right? After all, look at the P/E rating, which is sitting at a historical 49 or so. Surely future growth expectations are in the price. Maybe, but I wouldn’t count on that theory. After all, the historical P/E rating was at equally high levels before the growth we’ve already seen, happened.

Looking forward, city analysts reckon that earnings-per-share growth is likely to come in at about 16% in 2014 and 25% in 2015. Forward P/E ratings look more palatable at 43 and 34 respectively. Taking a steer from the investment philosophy of highly successful growth investor Philip A Fisher, we can learn to live with high P/E ratings if we consider them a mark of quality. If the qualitative factors of an enterprise stack up to support continuing high growth, Fisher’s approach is attractive.

The future looks bright

According to the directors, ARM chalked up a strong licensing performance in 2013 across its established markets and penetrated the server and smart embedded applications markets. 2014 opened with a strong opening order backlog and a robust pipeline of licensing opportunities. The firm is winning market share, with 2013 processor royalty revenue growing faster than the overall semiconductor industry by 18%.

The firm focuses on long-term growth markets, such as those for smartphones, tablets, enterprise equipment and embedded computing. The CEO reckons that Q4 saw the company’s latest technology chosen by major companies in all target markets, and such design wins will help ARM to drive future royalty revenues.

Growth seems set to continue at ARM and, if past performance is any guide to the future, which contrary to popular opinion it often is, I think there’s every chance you’ll be glad your ISA capital gains are tax-free if you’ve tucked ARM away in it.

What now?

Buying the shares of businesses driven by strong underlying fundamentals like ARM Holdings is an appealing investment proposition.

I've been trawling the FTSE 100 for firms with a strong investment case and I've found some in a FREE Motley Fool wealth report featuring five firms with strong economic positioning within their sectors.

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Kevin does not own shares in ARM Holdings