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Is ARM Holdings plc A Promising Capital-Growth Investment?

ARM HoldingsOne consistent feature of semiconductor intellectual property supplier ARM Holdings‘ (LSE: ARM) (NASDAQ: ARMH.US) financial performance in recent years is double-digit growth in earnings, sometimes high double-digit growth in earnings at that.

A highly rated company

The firm’s ability to deliver on growth is what keeps its rating high. The shares aren’t cheap, but then the performance of the underlying business isn’t feeble, either. Nevertheless, investors might fear that any weakness in earnings’ growth will immediately send ARM’s shares crashing downwards to adjust the P/E multiple so that it matches revised growth expectations.

I don’t think one weak quarter or half year will have such a dramatic affect on ARM’s forward valuation, though. When we look at ARM’s economic moat, achieved thanks to its strong position in the heart of its industry, it’s clear that the firm has resilience, and therefore forward valuations will likely adjust according to some average growth rate that the firm has achieved over several years.

Growing earnings

This is how earnings have grown recently:

Year to December 2009 2010 2011 2012 2013
Adjusted earnings per share 5.45p 9.34p 12.72p 14.96p 20.88p
Earnings’ growth (4%) 71% 36% 18% 40%

Last month, with the release of half-year figures, ARM said it expects the current year’s earnings to hit predictions of 11% growth. So, we have earnings’ growth figures for six years, and if we work out the average growth rate over that period, it comes out at almost 29%.

Because of this way of looking at earnings over several years and finding the average to inform valuation, I don’t think it is coincidence that, at a share price around 843p, ARM’s forward P/E rating for 2015 is running at just over 29, too.

Outlook

ARM reckons it enters the second half of the year with a healthy pipeline of opportunities, which it expects to underpin strong licence revenue and to increase order backlog. The firm cites market data indicating improving semiconductor industry conditions, which it thinks will drive acceleration in royalty revenue growth in the second half of 2014.

ARM’s CEO thinks the firm’s strong licensing performance reflects the intent of existing and new customers to base more of their future products on ARM technology. The company signed 41 processor licences in the second quarter thanks to demand for ARM technology in smart mobile devices, consumer electronics and embedded computing chips for the Internet of Things.  All of that bodes well for growth in ARM’s medium- and long-term royalty revenues, he says.

Indeed, City analysts following ARM Holdings predict 22% uplift in earnings for the year ending December 2015. Growth is still a prominent feature of ARM’s business and even looks set to ramp up in the years ahead.

What now?

ARM Holdings does look like a promising capital-growth investment to me and that’s why I hold some of the shares.

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Kevin Godbold owns shares in ARM Holdings. The Motley Fool has recommended shares in ARM Holdings.