They say that quality doesn’t come cheap, and investors in ARM Holdings (LSE: ARM) (NASDAQ: ARMH.US) Whitbread (LSE: WTB) and Burberry Group (LSE: BRBY) would no doubt agree: their shares are expensive for a good reason.
Despite this, I believe all three companies could still deliver further gains for investors, as I explain below.
ARM Holdings
ARM’s growth has repeatedly justified its premium valuation: ARM shares have delivered an average annual total return of 27% over the last three years, compared to 10% for the FTSE 100.
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What’s more, ARM appears to be growing into its valuation — the firm’s shares currently trade on a 2016 forecast P/E of 33 — the lowest rating for some years.
In my view, ARM’s success can be traced back to three main factors:
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Characteristic |
The evidence |
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Strong growth |
Sales have risen by an average of 14% per year since 2010, while post-tax profits have risen by an average of 24% per year |
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High profit margins |
ARM reported an operating margin of 39% in 2014 and the firm’s operating margin has averaged 30% over the last five years. |
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Rising shareholder returns and strong cash generation. |
ARM’s dividend has risen by an average of 19% per year since 2010. Net cash has risen from £141m in 2009 to £674m in 2014. ARM has no debt. |
As a value investor, I won’t be buying shares in ARM — but I do rate the shares as a buy for continued growth.
Whitbread
Shares in Costa Coffee-owner Whitbread have risen by 28% over the last year, compared to a gain of just 7% for the FTSE 100.
Although Whitbread shares now trade on a 2015 forecast P/E of 26, I believe there could be more to come.
Whitbread’s debt levels are low, and its operating profit margins are high, at around 17%.
Earnings per share are expected to rise by around 30% in 2015, while the dividend payout is expected rise by 12%.
The risk, in my view, is that Whitbread will carry its expansion plans for Premier Inn and Costa Coffee too far, reinvesting strong profits in new outlets that may provide diminishing returns. However, with earnings per share up 12% during the first half of the current year, there’s no sign of that happening yet.
Burberry
Luxury good manufacturer Burberry is up 12% so far this year and has gained 32% over the last year. The firms’ shares have consistently outperformed the FTSE 100 over the last 10 years.
Like ARM, Burberry has net cash and the dividend has risen strongly, increasing by an average of 18% per year since 2010. The quality is evident from Burberry’s operating margin, which has hovered between 17% and 20% since 2010.
Burberry’s earnings are expected to stabilise in 2015 and rise by 11% in 2016. The market has kept faith with the firm’s story of strong growth in overseas markets, and the shares are currently valued at 24 times 2015 earnings with a prospective yield of 2.0%.
