2014 has been a very different experience for investors in ARM (LSE: ARM) (NASDAQ: ARMH.US) than it has been for investors in Imagination Tech (LSE: IMG). Thats because, while the former has seen its share price slump by 13% since the turn of the year, the latter is up 18% year to date. However, ARM could prove to be a better buy than its sector peer and may outperform it moving forward. Heres why.
Reliable Earnings Growth
Looking at the two companies track records of earnings growth, its clear that ARM is a lot more reliable than its peer. For instance, ARM has delivered bottom line growth in each of the last four years, with it averaging 41% per annum over the period. However, Imagination Tech has increased earnings in two of the last four years and has seen the bottom line fall in the other two. This means that its average earnings growth rate during the period is just 4% less than one-tenth that of ARM.
This reliability looks set to continue at ARM, with the company forecast to deliver earnings per share (EPS) growth of 11% in the current year and 23% next year. This is in contrast to Imagination Tech, which is expected to continue its volatile earnings performance of the last four years by recording a decline in the bottom line of 19% this year, followed by a strong return to growth of 39% the following year. So, while ARMs bottom line is set to be 37% higher next year than it was last year, Imagination Techs earnings are due to be just 13% higher.
It may seem rather strange to mention income potential when discussing two technology stocks. However, ARM is increasing dividends per share at a rapid rate. For example, in 2009 the company paid a dividend of just 2.4p per share and next year it is expected to reach 8.2p per share. Thats growth of 23% per annum, which is very impressive and means that ARM is expected to yield 0.9% next year. Imagination Tech, meanwhile, pays no dividend.
Clearly, technology companies tend to trade at higher valuations to the wider market as a result of their premium growth rates. However, good value seems to be on offer at both companies. ARM, for example, has a price to earnings growth (PEG) ratio of 1.5 and this appears to indicate good value at current price levels, given the reliability of the companys earnings growth.
Imagination Tech, meanwhile, has a PEG ratio of 0.6. On the face of it, this looks more appealing than ARMs 1.5. However, due to its highly volatile earnings profile, Imagination Tech deserves to trade at a sizeable discount to ARM. Indeed, as a result of its strong track record, income potential, wider margin of safety and better future growth prospects, ARM looks to be the better buy right now.
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Peter Stephens has no position in any shares mentioned. The Motley Fool UK owns shares of Imagination Technologies and has recommended shares in ARM Holdings. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.