The FTSE 100 has risen 36% over the last five years. However, some companies have done much better than others. In fact, almost half have seen their shares rise 100% or more.
I’m currently looking at some of your favourite blue chips and analysing their prospects for doubling your money in the next five years. Today, it’s the turn of ARM Holdings (LSE: ARM) (NASDAQ: ARMH.US).
The last five years
ARM Holdings is the world’s leading semiconductor intellectual property (IP) supplier, designing and licensing fast, low-cost, power-efficient processors. The company has increased earnings per share (EPS) at a super-strong compound annual growth rate (CAGR) of close to 30% over the last five years.
ARM’s success, against the backdrop of rapid growth in smartphones, has come not only from the calibre of its technology, but also from the cuteness of its business model. The company aims for the initial licensing of its IP to cover operating costs, allowing ongoing royalties to snowball as the number of licences grows. Cash on the balance sheet has expanded from £142m at the end of 2009 to £746m today.
The next five years
Share price changes over any given period are driven by two things: growth (or decline) in EPS and any change in the price-to-earnings (P/E) ratio.
ARM’ shares are trading at 940p at the time of writing. In order to give investors today a 100% price rise over the next five years, ARM would need to increase its earnings at a CAGR of about 15%. And maintain its current P/E of 45.
However, if ARM was only able to do EPS growth of 15% (half the rate of the last five years), the market wouldn’t rate the company on a P/E as high as 45; we’d be looking at more like 25. And that would translate into a 5-year rise in the shares of little more than 10%.
So, to double your money, ARM needs to keep increasing EPS at a fast rate. If the company again delivered the 30% CAGR seen in the last five years, and maintained its current P/E rating, you’d be looking at a share price rise of about 270%.
As that return suggests, you could still double your money if ARM delivered somewhat lower earnings growth than 30% and rated on a somewhat lower P/E than 45. A mid-20s CAGR and mid-30s P/E would be good enough.
Could you double your money?
Can ARM deliver? Well, the company itself expects EPS to grow by at least 20% a year for the next five years.
Demand for entry-level smartphones and tablets in emerging markets is set to be one driver for ARM. Another, and potentially massive, driver is the so-called ‘Internet of Things’. Indeed, half the licences signed in ARM’s most recent quarter were for processors for such things as microcontrollers, smart sensors and low-power wireless communication chips.
Given ARM’s opportunities, and the company’s history of over-delivering on earnings, I think there’s every chance you could double your money with this stock over the next five years.
