Why You Should — And Shouldn’t — Invest In ARM Holdings plc

Today I am looking at the benefits and pitfalls of investing in chipbuilder ARM Holdings (LSE: ARM) (NASDAQ: ARMH.US).

Intel on the march

Those individuals warning that ARM’s dominance of the tablet PC and smartphone-component markets may be coming to an end took the high ground last week when US rival Intel Corporation (NASDAQ: INTC) released its latest set of results.

Intels blasted its 2014 shipping target of 40 million tablet processors in 2014 with a total of 46 million, a figure that propelled the firm’s market share from 5% in 2013 to 28% by the third quarter of 2014, broker Liberum Capital noted.

The company’s Mobile division was once again a blight on an otherwise perky financial update, the result of poor product development in recent years. But Intel has since got its act together and plans to launch two major products this year, a situation which could significantly hamper sales growth at ARM — the British company sources around 75% of all revenues from the phone and tablet sectors.

Diversification to deliver delicious returns?

Still, Cambridge-based ARM is responding to mounting competition across its core markets by diversifying into other high-growth tech sectors, and is chucking vast sums into developing its presence in the networking and servers markets.

Indeed, the company’s development of low-power, 64-bit server chips is gathering increased interest from the world’s biggest tech giants. HP announced in September plans to roll out two brand new ARM-based servers as part of its ProLiant range, while Microsoft has been trialling a Windows Server running on ARM’s hardware in recent months, according to reports.

Premium product demand remains worrisome

But such products represent a very small part of the pie for ARM, of course, which remains beset by fears of slowing sales of premium smartphones. With Western demand for top-end devices apparently at saturation point and consumers increasingly opting for lower priced models, royalties projections for the microchip builders are coming under increased scrutiny.

The roaring success of Apple’s iPhone6 in the autumn has gone some way to assuaging fears that shipments of premium phones are poised to fall off a cliff. But with sales of expensive devices at Samsung still falling through the floor, sceptics are on the lookout for more convincing evidence that the market is not in terminal decline.

Payouts set to pound higher

Of course the tech sector is not a natural hunting ground for those seeking gigantic dividends — the capital-sapping nature of developing the next line of gadgets leaves very little cash for companies to reward their shareholders with.

But ARM is a rare exception, and remains committed to delivering spectacular payout expansion in line with earnings. The chipbuilder has raised the annual dividend at a compound annual growth rate of 18.4% during the past five years, and City analysts expect this to head still higher.

For 2014 ARM is anticipated to deliver a 6.5p per share payment, up 14% from the previous years. But dividends are expected to accelerate thereafter in line with earnings, and rewards of 8.4p and 10.4p are pencilled in for 2015 and 2016, up 29% and 24% respectively.

So although yields register at just 0.8% for 2015 and 1.1% in 2016, these figures should stomp higher if ARM can keep the bottom line ticking along.

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