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Has Arm Holdings plc's (NASDAQ:ARM) Impressive Stock Performance Got Anything to Do With Its Fundamentals?
Arm Holdings (NASDAQ:ARM) has had a great run on the share market with its stock up by a significant 26% over the last three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to Arm Holdings' ROE today.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Put another way, it reveals the company's success at turning shareholder investments into profits.
View our latest analysis for Arm Holdings
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Arm Holdings is:
11% = US$641m ÷ US$6.0b (Based on the trailing twelve months to September 2024).
The 'return' is the income the business earned over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.11.
What Is The Relationship Between ROE And Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.
A Side By Side comparison of Arm Holdings' Earnings Growth And 11% ROE
At first glance, Arm Holdings seems to have a decent ROE. Further, the company's ROE is similar to the industry average of 12%. As you might expect, the 15% net income decline reported by Arm Holdings is a bit of a surprise. So, there might be some other aspects that could explain this. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.
That being said, we compared Arm Holdings' performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 21% in the same 5-year period.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Arm Holdings''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Arm Holdings Efficiently Re-investing Its Profits?
Because Arm Holdings doesn't pay any regular dividends, we infer that it is retaining all of its profits, which is rather perplexing when you consider the fact that there is no earnings growth to show for it. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
Conclusion
In total, it does look like Arm Holdings has some positive aspects to its business. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
About NasdaqGS:ARM
Arm Holdings
Arm Holdings plc architects, develops, and licenses central processing unit products and related technologies for semiconductor companies and original equipment manufacturers rely on to develop products.
Flawless balance sheet with high growth potential.