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3-Point Checklist: Should You Buy ARM Holdings plc, Rolls-Royce Holdings PLC Or BAE Systems plc?

Shares in Rolls-Royce Holdings (LSE: RR) rose by 3% when markets opened this morning, after the firm announced that Warren East would take over from John Rishton as chief executive at the engineering firm.

Mr East is best known to investors as the previous chief executive of ARM Holdings (LSE: ARM) (NASDAQ: ARMH.US), where he oversaw the firm’s growth into a world-leading chip design whose products are in nearly every smartphone.

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ARM and Rolls both offer investors a different way to back the best of British industry. In this article I’m going to compare these two firms with a third choice, defence giant BAE Systems (LSE: BA), to see which looks the most appealing buy in today’s market.

1. Earnings growth

 

Rolls Royce

ARM Holdings

BAE Systems

5-year average adjusted eps growth

11%

22%

-1.4%

2015 forecast earnings growth

-8.6%

67%

0%

ARM is clearly the growth star here, with Rolls Royce a respectable second — historically at least — and BAE lagging behind.

Looking ahead, Rolls is expected to have a difficult year in 2015, before returning to growth, while BAE’s guidance is for earnings per share “marginally higher” than in 2014 — so I’ve assumed no growth.

2. Dividend choices

For income investors, buying shares in ARM makes no sense. The firm’s 0.7% yield is below that available on cash savings.

However, Rolls and BAE both have clear attractions:

 

Rolls Royce

ARM Holdings

BAE Systems

5-year average dividend growth

7.6%

19.3%

3.2%

2015 forecast dividend growth

3.0%

23.9%

1.8%

2015 prospective yield

2.3%

0.7%

4.1%

Rolls-Royce’s dividend has grown faster, historically, but that growth is slowing and the firm’s 2.3% yield is considerably lower than the 4.1% available from BAE. Both dividends are expected to be covered at least twice by earnings, suggesting that BAE could be the best choice for an income buyer.

3. Is the price right?

As you’d expect, there are big differences in the valuations of these three companies:

 

Rolls Royce

ARM Holdings

BAE Systems

Trailing P/E

15.9

46.7

13.3

2015 forecast P/E

17.4

39.6

13.2

Investors will be watching carefully for any changes to guidance or strategy after Mr East takes charge at Rolls Royce on 2 July. In the meantime, the firm’s valuation relies on market confidence that Rolls can return to earnings growth in 2016, although Rolls Royce’s lack of debt provide additional downside protection.

BAE, on the other hand, looks cheaper, but does have a reasonable amount of debt and a track record of sluggish growth.

Today’s best buy?

In my view, BAE is a decent income buy, but for long-term investors seeking income and capital growth, Rolls could be a better choice.

ARM remains a stock for growth investors: the firm’s valuation is demanding, but it is an exceptional quality business with strong momentum behind it.

Ultimately, it’s your call.

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Roland Head owns shares of BAE Systems. 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.

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