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4 Ways ARM Holdings plc Will Continue To Lead The Technology Sector

Right now I’m comparing some of the most popular companies in the FTSE 100 with their sector peers in an attempt to establish which one is the more attractive investment.

Today I’m looking at ARM Holdings (LSE: ARM) (NASDAQ: ARMH.US).

Valuation

Unfortunately, ARM has almost no comparable London-listed peers, which means it is not possible for me to value the company in relation to its peers.

That said, in comparison to the wider technology and hardware sector here in London, ARM looks expensive. Indeed, ARM currently trades at a historic P/E of 64 while the technology sector trades at an average historic P/E of 50.

Still, ARM’s recent third-quarter results revealed that the company earned 5.11p per share for the quarter, which puts the company in line to achieve the full-year earnings per share figure of 20.71p, predicted by City analysts. This puts the company on a forward P/E of 46. 

Balance sheet

However, I believe that ARM deserves this high valuation. Why? Well, the company has a highly cash-generative business model and cash-rich balance sheet, two highly desirable traits for any company.

Indeed, at the end of the third quarter the company had nearly £671 million of cash with no debt. Furthermore, this cash pile had grown by around 29%, or £151 million from the end of 2012.

Actually, this cash position works out at around 48p per share, indicating that after deducting cash from the equation, ARM trades at a forward P/E ratio of 44.

What’s more, as the company is generating nearly £100 million in cash per quarter there is plenty of scope for special dividends. 

Company’s performance

As I have already mentioned, ARM’s cash generation is mainly down to the company’s high-margin business, which requires a small amount of investment for large recurring revenues.

In particular, ARM’s return on invested capital, a financial ratio that measures a company’s profitability and the efficiency with which its capital is employed, will be approximately 27% for 2013. In comparison, Wall Street analysts expect Apple‘s return on invested capital to be 26% for this financial year.

Furthermore, thanks to this business model, and the rise of the smart phone during the past five years, ARM’s earnings have exploded 163% since 2008.

Dividends

Having said all of that, ARM falls at the last hurdle as the company only offers investors a meagre dividend yield of 0.5%. However, this payout is covered more than three times by earnings.

Foolish summary

All in all, there are very few companies that can be compared to ARM and in my opinion, the company’s innovation and cash generation are second to none.

So overall, I feel that ARM is a much stronger share than its sector peers. 

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In the meantime, please stay tuned for my next FTSE 100 verdict.

> Rupert does not own any share mentioned in this article. The Motley Fool owns shares in Apple.