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Why ARM Holdings plc Is A Top ISA Buy

Microchip designer ARM Holdings (LSE: ARM) (NASDAQ: ARMH.US) needs little by way of introduction in this smartphone and tablet age.

appleBe it Apple, Android or Windows-flavoured — pick your poison — there’s little doubt that ‘mobile devices’ are at the beating heart of the online world.

You see, it’s ARM’s super-efficient, faster, smaller processor designs that put the “smart” in an incredible 95% of the world’s smartphones.

And although global smartphone sales are starting to slow after five explosive years of growth, I think buying ARM shares for your stocks-and-shares ISA right now could still be a very smart choice.

In fact, I believe next chapter in ARM’s growth story could just be getting started, thanks to the phenomenon that industry experts are dubbing ‘The Internet of Things’.

Cheaper, smaller, faster

Unlike US rival Intel, ARM makes money by charging license fees to chip manufacturers for use of its designs — receiving royalties for each device shipped using its technology. It’s a compelling business model.

But perhaps more importantly, thanks to its track record with smartphones, ARM already leads the way in the design of cheaper, smaller, more efficient microprocessors. And it’s that capability that could enable yet another revolution by unlocking the potential for manufacturers to “smarten up” our lower-end household appliances (at a cost that makes sense, too).

The dawn of a new age of connected devices

Although it might sound like something out of a science fiction movie, if this can be achieved — and industry experts will tell you this trend is already under way — then ARM’s grip on this niche market should tighten.

In fact, of the 650 billion silicon chips currently produced every year, only 27 billion currently contain a smart processor, with ARM’s designs inside around 9 billion of those.

In other words, only 4% of chips are even “smart” by today’s standards, and the other 96% that are going into appliances are actually still “fairly dumb,” according to ARM. That’s a huge market opportunity as these appliances become more advanced — and ARM sees its demand growing more than tenfold to 100 billion processors per year in the future.

And who really knows (or cares to bet) where the whirlwind consumer technology market will take us next? Could it be Google, Apple, Samsung or even Amazon? Personally have no idea, but I do believe all the big players will be paying a handsome royalty to ARM for its designs, regardless of who wins.

Valuation

Wit the shares currently trading on a forecast P/E of 41.6, there’s no getting away from the fact that ARM’s shares are fairly richly valued. 

Sometimes, however, it’s worth paying up for prospective future growth, and what you’re essentially buying here is a ‘racehorse’ — a pure and simple growth opportunity with an impressive pedigree.

ARM’s EPS growth is currently projected to grow by 16% this year, and by around 30% in 2015. However, with the shares trading at over 40 times future earnings, you’d better be prepared to shoulder a fair amount of volatility, too.

When selecting shares for your ISA, you ought to think long term -- the real money isn’t made by selling every time there’s an incremental rise, not with those pesky trading fees. Instead, you should consider shares that you’re happy to ‘buy and forget’.

That’s why our top analysts scoured the FTSE 100 to bring you five names that they believe can form the heart of your portfolio, including a Big Pharma dividend champion, a giant with two billion consumers every day, an omnipresent high-street hero , a defensive Goliath and a power play with a 5%+ yield.

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Andrew does not own shares in any company mentioned. The Motley Fool owns shares in Apple and Google.