Investment Analysis: ARM Holdings.

ARM Holdings, Microchip manufacturer
ARM Holdings, Microchip manufacturer

ARM Holdings is a microchip multinational company, with its HQ in Cambridge, England. The company has been somewhat of a British success-story over the past few years, competing with the likes of Intel in the microchip business and securing major clients such as Apple. This has seen their share price rocket from 469 per share (17th July 2012) to a height of 1096 (16th May 2013). The share price currently (5th August 2013) sits at 881.

I used the Income Statements and Balance Sheets available at The London Stock Exchange to do some investment ratios, to get an idea of the strength of ARM Holding’s fundamentals.

Fundamental Analysis: Ratios

Ratios Dec. 2012 Dec. 2011
Profitability
Operating Profit margin 36.07% 30.27%
R.O.C.E 17.65% 14.22%
ROSF 13.32% 10.61%
Liquidity
Current ratio 2.8:1 2.25:1
Acid Test ratio 2.83:1 2.24:1
Efficiency
Receivables days 173 days 116 days
Payables days N/A N/A
Inventory turnover days N/A N/A
Financial
Gearing 2.19% 1.35%
P/E 65.64 70.48

What do these ratios say about ARM Holdings?

Lets start with Profitability.

Operating profit:

  • Change: Risen +5.80%. This shows that the company is more profitable then the year before.
  • Reason for change: Expenses could be lower, indicating better management of costs. However their Income Statement suggests it might be a result of vastly higher revenues.
  • Verdict: Good, although we need more information on expenses.

Return on Capital Employed:

  • Change: +3.43%.
  • Reason for change: A result of more efficient use of capital employed.
  • Verdict: Good

Return on Shareholders Funds

  • Change: +2.71%.
  • Reason for change: With an increase of profit of £50m from 2011 to 2012 you would expect a larger return to the shareholders, therefore this might indicate a increase in debt.
  • Verdict: Average

All profitability ratios calculated have seen a rise in their percentages, this is good as it indicates that ARM Holdings are gaining better margins on their products. This could be the result of reduced costs, or of increasing the mark-up of their product.

Liquidity

Current Ratio and Acid Tests

  • Change: +0.55:1 and +0.59:1 respectively.
  • Reason for change: Indicates value of current assets rising faster then that of current liabilities.
  • Verdict: The ratios are currently quite low, it is said that 1.5:1 is a good level to sit at. This signals to the company (and investors) that ARM Holdings could make more effective use of it’s current assets, and/or employ more current liabilities.

The current ratio and acid test both have high ratios, this is a good indication as it suggests that the company is very liquid and will be able to pay off any creditors with ease.

Efficiency

Receivables Days

  • Change: +57 days. It is taking 57 days more to receive their payment for their products, than the previous year.
  • Reason for change: Less efficient collection of credit. This could be down to bad management, in terms of negotiation of terms; but also as a ‘second tier company’ (one that supplies for a much larger company) it is expected that the larger companies (such as Apple) will have greater leverage over ARM Holdings.
  • Verdict: Poor, but no major surprise.

Unfortunately the London Stock Exchange does not offer information on the other two efficiency ratios.

Financials

Gearing:

  • Change: +8.4%.
  • Reason for change: An increase in liabilities. Gearing, however, still remains well below average.
  • Verdict: Good/Poor. Good as it indicates low debt obligations, but poor as it signals that management could take on more debt that might allow for more growth.

P/E:

  • Change: -4.16.
  • Reason for change: The price of the share is getting closer to it’s earnings.
  • Verdict: Good. As the ratio is above 25 it indicates that the market expects a very high level of growth from this company; signalling to investors that this share is expected to see a higher share price. It is also a risky share as the investor is paying 65.64 for every 1 of earnings per year.

Can’t value a company on two accounting periods alone.

Although these ratios help give us an idea of how ARM Holdings is operating financially, it is un-wise to judge a company on ratios from just two accounting periods. We would need to compare the ratios with industry averages and other similar companies (such as Intel) to get an idea of where ARM holdings stands in the market. Furthermore different accounting methods can change how the company is viewed in it’s ratios; ARM Holdings might be employing accounting methods that make the company’s profits non-comparable to Intel’s profits, as the different methods used by the two companies mean their profits are vastly contrasting.
Furthermore this post magnifies the issue that individual investors have, as I’ve been unable to secure reliable data for some of ARM Holding’s fundamentals; including Expenses and two Efficiency ratios.

Technical Analysis

Stock Brokers

Majority of brokers putting a 1000+ price tag on the shares, including Citigroup and Investec Securities.

ARM-two
©The Share Centre

Graphs

4trader’s technical analysis from the past performance of ARM Holdings signals a support level at 830 and a resistance at 921. This indicates to the investor that should the share price drop below 830 then there is likely to be a sell-off, however if it were to rise above 921 it is probable that the share price might rise further.

It is important to recognise that technical analysis is based on past performance and therefore is not 100% reliable. It is no substitute for fundamental analysis, but does provide useful information on when the best time to buy the share is; for example it would be ill advised to buy the share just as it breaks its support level.

My View
ARM Holdings has had some great momentum recently, especially after securing contracts with Apple. However seeing as Apple is suffering from poor sales of its products recently, as an investor, we should be weary as to how that might affect ARM Holding’s revenues. Also, as ARM Holdings do not personally manufacture the micro-chips, but rather licenses their use out, investors should keep a close eye on how ARM Holdings is doing in terms of securing licensing agreements and renewals; should they lose the licensing with Apple we would surely see a major fall in the share price.

I am not liable to any investment decisions made by this post, however I do hope its been an enlightening read.

-Ed

Tweet me your thoughts on ARM Holdings and its future @Breadeconomics

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