ARM Holdings plc Could Be Worth £16.80

It’s always difficult to put a value on a high-growth technology stock, especially one like ARM Holdings (LSE: ARM) (NASDAQ: ARMH.US), the company that designs the chips that power iPhones, iPads and a large proportion of the world’s mobile computing devices.

Highly priced

ARM HoldingsIt doesn’t help that ARM’s shares have been very highly, and rather erratically, valued. In fact, over the past five years the price is up almost 800%! But over the past 12 months it’s gone precisely nowhere, standing at 916p as I write.

When the year to December 2013 ended with a 40% rise in earnings per share (EPS), ARM shares finished on a price to earnings (P/E) ratio of nearly 53, which is more than three and a half times the FTSE’s long-term average of around 14.

But after that flat 12 months, and with a 14% rise in EPS forcast for 2014, the shares are now on a forward P/E of 38, dropping to 31 based on 2015 predictions.

But still cheap?

That’s still high compared to the typical plodding blue chip share, but by ARM’s standards it looks almost like a giveaway. Can ARM’s earnings rise by enough to potentially bring the P/E down further?

Well, tentative forecasts suggest EPS could more than double by 2018 to 43p, and if the share price doesn’t move at all that would suggest a P/E of around 21 by the end of that year.

I’m pretty sure the demand for ARM’s chip designs is still going to be very strong by then, and a P/E that’s considerably higher than average will surely continue to be justified.

Sustainable value

If we assume the current forward P/E of 38 is sustainable (and it’s the lowest it’s been for five years), that doubling of earnings would give us a share price of around 1,635p for a very nice gain of 78% on today’s price.

ARM isn’t much of a dividend payer, with yields only just perking above 0.5%, but we could still have around 45p to add to that to take us to 1,680p and an overall gain of 83%.

Can ARM’s earnings growth really continue at today’s rapid pace?

Well, at the time of its Q1 report in April, the company told us that 2.9 billion ARM-based chips had been shipped in the quarter, up 11% from the previous year — and that’s a staggering number of the little silicon things! We also heard of “Strong year-on-year shipment growth especially in enterprise networking and microcontrollers“, and demand in those areas can surely only carry on up.

Definitely not average

ARM’s share price might look high by average measures, but ARM is definitely not an average company — and highly-priced shares can indeed be cheap.

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Alan does not own any shares in ARM Holdings.