ARM Holdings and the Internet of Things

11/10/2015 10:00 am EST

Focus: STOCKS

Stephen Leeb

Founder and Research Chairman, Leeb Group

The Internet of Things (IoT), whereby objects connect to one another in a vast network servicing our everyday needs, is moving toward reality, explains Stephen Leeb, editor The Complete Investor.

A simple example already in use is a home thermostat that can be regulated remotely by a smartphone. Ultimately, IoT might encompass entire smart cities, where everything and everyone, from residents and vehicles to homes and fire departments, are linked.

It could take a while before IoT achieves full fruition—estimates vary widely—but there’s little doubt it will happen. For investors, the question is just how big an opportunity it represents. The answer is very big indeed.

There’s consensus that growth in this area will hit 25% to 30% a year, with the leading players reaping profits that in the aggregate could be in the hundreds of billions of dollars or even in the trillions.

Another explosively growing variable relates to the data funneled through these connections, which even according to the lowest estimates of how many items will make up IoT will be growing at a compounded rate above 50% a year through 2020 and beyond.

One company in the forefront of developing the products and software critical to IoT is Britain-based ARM Holdings (ARMH), the world’s leading designer of specialized semiconductor chips.

As of yearend 2014, ARM-designed semiconductors and related products were in 37% of the world’s smart devices and they will power around 50% of all smartphones shipped this quarter.

And thanks to the compatibility of its smartphone chips with chips in other parts of IoT, the company also has gained a strong foothold in network chip design.

The company’s leading position in critical chips gives it a huge edge in maintaining that lead, nearly ensuring that the smartphones of the future will depend on ARM-based chips.

ARM’s revenues come from the royalties it collects on its chips. The more complex the chip, the higher the royalty it gets.

We see the stock as a strong pick not just because of its market position and strong projected growth but also because royalty-based companies have inherent protection against risk.

ARM carries no debt and generates plenty of free cash, which it uses for acquisitions, share buybacks, and even a small but growing dividend. Of the relatively small companies in the IoT/E space, ARM should be a core position.

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