Why You Should Let ARM Holdings plc Look After Your Money

ARM Holdings

One of the cool aspects of analysing stocks and investing is that you get to learn (often intimately) the workings of a company. You can explore new worlds and work out how things are made, and who made them.

Now I have to be honest with you, I’m a bit of a granddad when it comes to technology. I don’t have the foggiest how a mobile phone actually works. I can tell you a little bit about how satellites work, but the inner workings of a cell phone are a little beyond me. Fortunately though you don’t need to be a tech wiz to make some money out of ARM Holdings plc (LSE: ARM) (NASDAQ: ARMH).

How it works

ARM spins straw into gold in a couple of different ways. It sells intellectual-property licenses for its designs to manufacturers, and it charges royalties when it ships the chips. Simple! So how’s it doing with that? Quite well, actually.

It currently produces a net profit margin of around 20%. Moreover, its five-year net income growth rate is also around 20%. In addition, ARM is sound from a credit or solvency perspective, with a quick ratio of 3.4. Investors are laughing all the way to the bank. In the past, capital gains have been solid, while ARM’s dividend growth rate is highly competitive at 20%.

I should note the firm was hit with an exceptional charge of over a million pounds during the last accounting period, but, as the name implies, it appears to be a one-off cost and doesn’t seem to point to any serious flaws in the company — apart from some management oversight.

Too good to be true?

Here’s where it gets a little awkward. The chip maker has a price earnings multiple of 80 times. Its forecast P/E is around 38. So analysts are expecting some froth to come of the share price in the short term, but even a P/E of 38 could lead to altitude sickness. Can it sustain those levels? I’d like to argue it can (at least in the medium term).

Here’s where I’d like to have a little fun. Just look at these company statistics (taken from the company’s accounts): its chip designs (ARM designs the computer chips that go into your smartphone) are found in more than 95% of all smartphones; the company shipped more than 10 billion chips in 2013 (20% increase in previous year); ARM’s market share grew 35% over the period, and it expects that to grow further; finally, ARM says it expects unit shipments and royalty revenues to grow — like they’re not high enough already…

The next big test

The ‘Internet of Things’ is the next technological wave (sorry, you’ll have to wait a little longer for the hoverboard). It will be neat though to be able to turn on your house lights, set the air conditioning, turn the TV on, and start dinner, all before you’ve arrived home. That technology is already here and ARM Holdings is moving into that area (technologically and through acquisitions). Analysts estimate that the semiconductor market for the Internet of Things will be $10 billion to $13 billion in 2015, rising to $45 billion to $50 billion by 2020.

So, yes, I concede that ARM Holdings’ valuation/share price looks extraordinary at present, and may well be bruised in coming months, but, long term, I suspect this company has a bright future. Did you see the queue in Manhattan for the latest iPhone?!

Deciding whether to invest in a stock like ARM Holdings is tricky because it's hard to tell if you've missed the boat or not. Then again, why not just look at the company as a whole? How is management performing? Where and how is the company planning on growing? All these factors go into what the Fools like to call 'careful stock selection'.

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David Taylor has no position in any shares mentioned. The Motley Fool UK has recommended ARM Holdings. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.