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Is Spirent Communications Plc A Better Buy Than ARM Holdings plc?

Shares in Spirent (LSE: SPT) are around 3% weaker today after the communications specialist reported a challenging start to the year. In fact, the company’s revenue slumped from £75m in the first quarter of last year to £65m in the first quarter of the current year. That’s a fall of over 13% and, while Spirent was anticipating a difficult start to the year, it has clearly hurt investor sentiment nonetheless.

Part of the reason for the dip in sales was, of course, the timing of a shipment of hand-held test tools worth around £11m. Last year, they were shipped in the first quarter of the year and so, when excluded, Spirent’s performance is much better. However, it continues to experience relatively weak demand across Europe, the Middle East and Asia.

Looking Ahead

As mentioned, Spirent was expecting a tough start to the year, but has also remained steadfast in its guidance for the full year. In fact, Spirent expects to see an increased level of demand as the year progresses and believes that order activity is showing signs of improving momentum. This is clearly good news for investors in the company and, looking ahead, Spirent is set to post very strong earnings performance over the next two years; aided by an improving top line.

For example, Spirent is forecast to increase revenue to £321m this year and then to £339m next year. This should have a positive impact on the company’s bottom line, with Spirent expected to post earnings growth of 24% this year, followed by a rise of 19% next year. And, despite trading on a price to earnings (P/E) ratio of 17.6, Spirent appears to offer excellent value for money due to it having a price to earnings growth (PEG) ratio of 0.8, which indicates that its shares could bounce back strongly from their 11% fall in the last year.

Sector Peer

Of course, ARM (LSE: ARM) (NASDAQ: ARMH.US) tends to be the preferred choice for investors seeking to gain exposure to the UK tech sector. And, looking at its prospects, it appears to offer significantly better growth potential than Spirent since it is expected to post earnings growth of 74% in the current year, followed by 20% next year. As such, it is understandable why ARM is likely to be the favoured option for most investors.

However, ARM’s current valuation appears to price in much of this growth potential, with it currently trading on a PEG ratio of 1.5, for example, That’s almost twice Spirent’s rating and indicates that, while ARM is benefiting from improving investor sentiment that has pushed its share price higher by 28% in the last year, it could underperform relative to Spirent moving forward.

That said, Spirent appears to be a riskier investment than ARM. For example, it has a less stable track record of profit growth and, as today’s results have shown, has reported a tough first quarter. As such, for more risk averse investors, ARM appears to be the better buy but, for investors who can live with greater risk and volatility, Spirent could offer greater capital gains over the medium to long term.

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Peter Stephens 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.