At a share price of 225p, Vodafone trades on 47 times forecast earnings for its financial year ending March 2016, while buyers of ARM at 1,005p are paying 33 times expected earnings for the year ended December 2015.
These are growth-company ratings. But can Vodafone and ARM deliver the growth to justify them, and drive strong returns for investors?
Vodafone is coming to the end of a massive two-year investment programme for future growth. Capex for 2014/15 was 9.2bn, and by the end of 2015/16 (March) the company will have invested a further 8.5bn to 9bn.
The investment isnt expected to produce growth this year, with revenue forecast to decline by 3.4% and earnings by 14%. However, for 2016/17 top-line growth of 2% is forecast, with earnings rising 21% on the back of the one-off benefit of a return to normal annual capex. The fruit of Vodafones heavy investment is forecast to really start paying off in 2017/18, when organic earnings growth of 18% is pencilled-in.
If forecasts are on the button, the P/E will have fallen from the current 47 to 33 in two years time, if the share price doesnt change. That doesnt seem a particularly attractive proposition, when you consider that ARMs P/E is 33 today.
I suspect Vodafones shares are as high as they are, partly because of the companys attractive dividend: the yield is over 5% at the current share price. The market may also be pricing-in the possibility of a bid for the company or potential M&A activity to drive earnings growth at a faster rate than currently projected.
However, as things stand, I dont see the combination of Vodafones P/E and earnings growth driving a large increase in the share price over the next couple of years, although investors should benefit from a decent income.
Microprocessor designer ARM has been a top growth blue chip for some time now, having enjoyed a strong tailwind from the smartphone revolution. Analysts are expecting the company to post revenue and earnings growth of over 20% when it announces its 2015 results next week.
However, the City experts are predicting that top-line and bottom-line growth will moderate to mid-teens increases for both 2016 and 2017. On these forecasts, the current P/E of 33 falls to 26 in two years time, again if the share price doesnt change.
Im optimistic that ARMs performance will drive strong returns for investors. In past years analysts have regularly found it necessary to upgrade their forecasts as the year progresses. And even then, the company has often gone on to beat the updated consensus.
With its strong and broadening network of partners, and its technology being deployed in an increasingly diverse range of products and markets (including the ubiquitous sensors that will form the Internet of Things), I expect ARMs earnings to continue to surprise on the upside. And I see the stock as very buyable at current levels.
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G A Chester has no position in any shares mentioned. The Motley Fool UK has recommended 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.