I don’t doubt that ARM can grow EPS at an extremely high rate for the next few years. But if EPS grows at 40% annually for the next 5 years the stock currently trades at 17 times those 5-year earnings. The most profitable devices for ARM are high-end smart phones and computing devices, and these are the devices which Intel is striving to gain market share. ARM had essentially no competition in these categories since Intel’s offerings weren’t efficient enough, but that could very well change in the coming years.
ARM is trading at a price which assumes that the best-case scenario for ARM is a guarantee. If ARM’s growth slows at any point during the next few years the stock is going to take a nosedive. ARM Holdings plc (ADR) (NASDAQ:ARMH) is a great company with a great business model, and I suspect that ten years from now it will be far more profitable than it is today. But I don’t see much justification for paying 90 times earnings for the company.
A look to the past
There was a time when Advanced Micro Devices, Inc. (NYSE:AMD), competitor to Intel, was trading for around 100 times earnings. In late 2006 AMD peaked at about $42 per share on EPS of $0.40, 60% growth from the year before. Then, as it always does, reality caught up with the stock and it tumbled. Advanced Micro Devices, Inc. (NYSE:AMD) couldn’t compete with Intel, and years of losses followed. Now, AMD trades at about $3.60 per share and is in danger of bankruptcy. ARM is in a far better position than Advanced Micro Devices, Inc. (NYSE:AMD) was in 2006, but you should never count Intel out. The company spent $10 billion on R&D in 2012 along with $11 billion in capital expenditures; combined this is about ARM’s entire inflated market capitalization. One way or another Intel will push its way into the mobile market, threatening ARM’s most lucrative products.
The bottom line
Although ARM’s business model ensures high margins and growth is likely to be high for the next few years the current price tag of 90 times earnings is far too high to pay for the stock. ARM Holdings plc (ADR) (NASDAQ:ARMH) has enjoyed little competition in mobile devices but that will eventually change as Intel produces more power-efficient chips. I don’t doubt that ARM will have much higher earnings ten years from now, but if you pay 90 times today’s earnings you’ll almost certainly be disappointed.
The article Is This Tech Stock Inflated? originally appeared on Fool.com and is written by Timothy Green.
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