The Motley Fool

Why Pace plc Could Be A Better Buy Than ARM Holdings plc After Lifting Forecasts

Today’s update from Pace (LSE: PIC) is hugely encouraging and could lead to the set-top box manufacturer posting record results for the full year.

The company has delivered better than expected profitability in the period from 1 July to 17 November and, as a result, it has raised its full-year profit expectations. A major reason for this is higher margins than previously anticipated, with an operating margin of over 9% now forecast (versus a previous forecast of 8.5%) for the full year due to an improved revenue mix and procurement savings from ongoing supply chain effectiveness improvements. This equates to a full-year adjusted EBITA forecast of over $235 million (compared to $194 million last year), with Pace also anticipating free cash flow in excess of $200 million for the period.

Of course, while margins are set to be higher than expected, revenues are due to be slightly below previous guidance. The main reason for this is a short-term shift in phasing from this year to the next year, with revenue now set to be between $2.6 billion and $2.65 billion for the full-year (down from previous guidance of around $2.7 billion). Despite this, the market has reacted extremely positively to the update, with shares in Pace being up as much as 9% today.

Looking Ahead

Despite offering earnings growth potential of 14% in the current year and 8% next year, Pace trades on a remarkably low valuation. For example, its price to earnings (P/E) ratio is just 10.8, which is considerably below the FTSE 100’s P/E ratio of 15.4 and shows there is upward rerating potential.

Indeed, Pace’s valuation is also well behind that of sector peer, ARM (LSE: ARM) (NASDAQ: ARMH.US). Its P/E ratio of 37.3 appears to be overly high at first glance but, when you consider the company’s excellent track record of earnings growth (it has averaged 41% per annum over the last four years), and the growth potential that is on offer over the next two years, it appears to make sense as an investment.

That’s because ARM is expected to grow its bottom line by 14% in the current year, and by a further 22% next year. This puts it on a price to earnings growth (PEG) ratio of 1.4, which means it appears to offer growth at a reasonable price. Despite Pace having a lower forecast growth rate, though, it has a PEG ratio of just 0.8, which is more appealing than that of ARM and could mean it is a better buy.

So, while both technology companies still offer huge potential, the lower priced Pace could prove to be a more profitable investment moving forward – especially if it can continue to deliver record levels of profitability in future.

Indeed, investing in companies such as ARM and Pace could boost your bottom line in 2015 and beyond. And, here at The Motley Fool, we think that everyone can generate improved returns through following a simple step-by-step process when investing.

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