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Can Spirent Communications Plc And Imagination Technologies Group plc Oust ARM Holdings plc From Your Portfolio?

ARM HoldingsIt’s been a disappointing six months for investors in ARM (LSE: ARM) (NASDAQ: ARMH.US), with shares in the intellectual property-focused technology company falling by over 22% since the turn of the year. While a better performer, Spirent (LSE: SPT) is down 8% over the same time period as both technology companies have failed to outperform the FTSE 100‘s flat performance.

However, industry peer Imagination Technologies (LSE: IMG) has posted gains of over 14% as the semiconductor researcher and licencing company has enjoyed strong demand among investors after a disappointing 2013, when smartphone sales disappointed and hit the share price hard.

Indeed, despite their stronger relative performance so far in 2014, could either Imagination Technologies or Spirent really oust the UK’s most prominent technology company, ARM, from your portfolio?

Growth Potential

Clearly, technology stocks are focused on growth to a larger extent than most companies in many other sectors. So, it’s perhaps disappointing to see that forecasts for Imagination Technologies show that earnings per share (EPS) are expected to fall by 18% in the current year. This is perhaps surprising, given the previously mentioned strength in the company’s share price. However, next year looks set to be a different story, with investors seemingly looking ahead to earnings growth of 38%.

Indeed, this is slightly ahead of growth rates for ARM and Spirent, which are expected to increase their bottom lines by 23% and 34% respectively next year. Unlike Imagination Technologies, though, ARM and Spirent are due to post strong growth numbers in the current year, too, with ARM’s bottom line due to grow by 13% this year and Spirent’s set to increase by 14%.

Good Value?

Judging high-growth stocks such as Spirent, ARM and Imagination Technologies solely on price to earnings (P/E) ratios is, of course, going to make them appear overvalued. That’s because relatively high growth rates push up valuations to a large extent, so a price to earnings growth (PEG) ratio that takes into account expected growth rates can be a more useful means of identifying good value stocks.

With regards to ARM, Spirent and Imagination Technologies, they currently trade on P/Es of 36, 25 and 30.8 respectively. However, when next year’s growth rates are taken into account, their respective PEG ratios are 1.57, 0.74 and 0.81 respectively. This shows that there is a marked difference in the valuations of the three companies, with Spirent and Imagination Technologies appearing to offer better value than ARM due to their lower PEG ratios.

Looking Ahead

Clearly, ARM trades at a premium to its peers as a result of its highly efficient business model as well as the fact that the company offers a greater stability of earnings. Indeed, unlike its two peers, ARM has delivered earnings growth in every one of the last four years. So, while Spirent and Imagination Technologies appear to offer better value, ARM still remains an obvious technology stock for investors who are seeking a mix of growth, value as well as greater stability than technology companies such as Spirent and Imagination Technologies can offer. For more risk-seeking investors, though, ARM’s two peers could be the preferred choice.

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Peter Stephens has no position in any shares mentioned. The Motley Fool recommends Spirent Communications and ARM Holdings. The Motley Fool owns shares of Imagination Technologies.