ARM Holdings(LSE: ARM) is one of Londons market darlings, and one of the UKs greatest success stories. Over the past ten years, ARMs shares have risen seven-fold, and there seems to be no end to the companys growth.
Whats more, ARM has been able to accomplish this growth without taking on any debt. The company has around 700m of cash on its balance sheet at present and is generating cash at a rate of 90m per quarter.
Unfortunately, ARMs prospects are currently tied to the success of Apple. When Apple reported sales results that missed expectations earlier this week, the company, along with many of its supplies, including ARM, saw billions wiped off their market values in the space of a few hours.
Apples third quarter iPhone sales increased by 35%. However, analysts were expecting a better result. ARMs first-half pre-tax profits rose by 28%, on a 15% increase in revenues, but even this growth wasnt enough to stop the chipmakers shares falling in sympathy with Apple.
ARM is heavily reliant upon smartphone sales for growth and is banking on continued strong growth in this sector. Managementestimatesthat half of all smartphones sold this year will contain ARMs latest chips but the fact that Apples sales missed expectations, could be interpreted as a warning.
Indeed, as one of the largest players in the global smartphone market, Apple is a bellwether for industry sales.
So, as Apple missed Wall Streets forecasts, it could be the case that industry sales are slowing, and analysts have been over-optimistic about smartphone markets growth.
Diversification
ARM is currently working to diversify away from its traditional smartphone market and Apple. The company is looking to the internet of things (IoT) market, where its high-performance, low-power chips are in demand.
And ARM signed a record 54 new processor licences during the second quarter of this year as IoT technology really started to take off. However, ARMs revenues from licencing during the quarter only expanded 3% to $151m as much of the financial benefit from these deals will come in later years.
Still, the figures show that ARM is working hard to diversify away from its traditional smartphone market. Nevertheless, it will take several years before the company has grown out of its reliance on Apple.
High expectations
ARM needs to sustain its current rate of growth to justify its high valuation.
For example, at present levels ARM is trading at a forward P/E 36.2. Earnings per share growth of 73%isexpected this year. This rich valuation does not leave much room for error if ARMs growth rate starts to slow. But with Apples sales already coming in below expectations, ARMs growth could also take a hit.
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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has recommended ARM Holdings. The Motley Fool UK owns shares of Apple. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.
Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has recommended ARM Holdings. The Motley Fool UK owns shares of Apple. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.