Wednesday, February 10, 2010

ARM Holdings Surfing The Smartphone Tsunami

ARM Holdings (ARMH) is a UK based chip designer that is parlaying its licensing and royalty talents into the smartphone revolution. They are not a high profile stock like AAPL, QCOM, RIMM, or GOOG; and were snubbed by Cramer's Smart Phone Index initiated 8/12/09. But ARMH has out performed all of these names and the index since last June, up 53% since I wrote a post about them and the smartphone hurricane on July 1 (click to enlarge)

In response to a viewer question, Jim Cramer has apologized for not having ARMH in his index, saying it should have been included. Back then, the valuation was a pain and had to be overlooked for a value investor to love the stock. After the climb since then it is even more of a pain: price/sales 8.0, price/cash flow 27, PE 70 - ouch! ARMH's eps is pretty flat over the last 10 years and, obviously, a lot of the tsunami future has been pumped into the stock price now. How much more can it take? If one had bought some back in June, one might want to take some off the table. But this stock is probably a buy on any sell-off that might send it to better valuations.

Bears on the stock point out that royalty rates are tending to come down as everyone buys a smartphone and more pricing pressure is induced. But this is countered by Morningstar's analysis that "as demand for outsourced chip designing grows, we expect this capable chip intellectual property (IP) designer to expand its footprint in more markets..." (other than the mobile market). But this strays from the tsunami. The commoditization of the smartphone may have some hard-to-predict investing consequences even as the tsunami itself advances - much like the internet revolution has left most publicly traded plays behind in its dust over the last 15 years. Here, an investor has to respect the technical condition of the related stocks and recognize when a good trend is breaking down or gearing up.

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