Right now I’m analysing some of the most popular companies in the FTSE 100 to establish if they are attractive long-term buy and forget investments.
Today I’m looking at ARM Holdings (LSE: ARM) (NASDAQ: ARMH.US).
What is the sustainable competitive advantage?
Traditionally, the market for low-power, high-performance semiconductors has been dominated by ARM. Even sector leader, Intel, has not been able to compete with ARM’s impressive technological achievements.
ARM’s success is partly down to its business model. You see, unlike the majority of the company’s peers, ARM does not manufacture its products. Instead, the company licences its intellectual property rights to companies such as Intel and Samsung, which then manufacture the semiconductors.
This strategy allows ARM to keep costs low and profits high. For example, the company’s cost of goods sold accounted for only 6% of revenue during 2012.
Furthermore, the business model means that the company has more cash available for research and development, which gives the firm an intellectual edge over its peers. In particular, during 2012, ARM spent 29% of its revenue on research and development, while peer Intel could spend only 15% of revenue.
Moreover, even after research costs, the company is still pocketing a net profit margin of 39%, excluding exceptional items, up from 21% during 2010.
What is the long-term outlook?
Despite ARM’s current strengths, the company’s outlook is hard to predict, as in the world of technology, things tend to move quickly.
In particular, even though ARM itself has been around since the 1980s, the company has not always enjoyed the mega-growth associated with the microchip industry. Indeed, between 2001 and 2009, ARM’s revenue grew at a compounded annual rate of 11%. However, since 2009, the company’s revenue has grown at a compounded annual rate of 25%.
What’s more, competition within the sector is really starting to heat-up with industry behemoths, IBM, Google and NVIDIA announcing a partnership earlier this month. The trio are opening up intellectual property rights and sharing research in an attempt to break ARM’s dominance in the sector and produce a new generation of faster, smaller processors.
Still, the demand for computer microchips will only rise over the longer term, so ARM will always have a market. It just remains to be seen if ARM can maintain an edge over its peers.
In the world of technology, things move very quickly and even though ARM is currently dominant in its market, the situation could quickly change, which requires investors to keep a constant watch over the company’s and the industry’s outlook.
As such, I rate ARM as a very poor share to buy and forget.
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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 Google.