How ARM Holdings Became a 20-Bagger

LONDON -- ARM Holdings  (LSE: ARM  ) (NASDAQ: ARMH  ) went public on April 17, 1998, meaning next month marks its 15th anniversary as a listed company.

It was one of the hot stocks of the dot-com bubble here in the U.K., but one of the few that is still thriving today. It started life as part of Acorn Computer Group, perhaps most famous for the BBC Micro, and was spun out as a separate company in 1990.

Unlike many tech stocks, it was profitable from a very early stage. Its 1998 annual report shows that it made a profit as least as far back as 1994, well before it joined the market. Profitability was very unusual for tech stocks back in the 1990s, and was due to the smart way its business model operates.

ARM designs chip processors and then licenses this technology to its various partners. An initial license fee typically covers ARM's development costs, and then a royalty fee for each chip manufactured by its partners should represent almost pure profit thereafter.

The roller coaster
ARM's flotation price was 575 pence back in April 1998. Share splits since then make this price equivalent to around 43 pence today. The shares did very little for several months, and you could still pick them up for much the same price in November 1998.

Investors then started to take notice, as they scrambled around for anything remotely connected to the Internet. The shares ended 1998 at 64 pence. By the middle of 1999, they were 146 pence, before soaring to 828 pence by the end of year.

They peaked at 1,010 pence in February 2000, before starting a long decline. On October 2, 2002, the company issued a profits warning and its shares slumped 63% in one day from 126 pence to 47 pence, pretty much back to their flotation price.

That marked a low, and shares steadily climbed to around 160 pence before the financial crisis struck. You could have picked up the shares for as little as 80 pence during January 2009. They now change hands for around 950 pence.

ARM in 1998 and 2012
It's interesting to compare some stats for the business when it listed and today.

Metric

1998

2012

Sales

42 million pounds

577 million pounds

Profit before tax

9 million pounds

221 million pounds

Chips shipped

50 million

8,700 million

Partners

32

954

Staff

350

2,400

Market value

280 million pounds

13,100 million pounds

Profit growth has outstripped both growth in sales and staff numbers. However, the need to continually develop its products has meant its profit margins haven't expanded quite as much as you might expect.

Indeed, looking at ARM's 1998 annual report and the 2012 version, you can see how the fundamental way it operates its business has stayed much the same over the years. The metrics used to judge its business look very familiar; however, the pictures of the products its chips powered back then do look somewhat dated!

A confession
I would like to say that I'm an ARM shareholder, and that I've held them throughout the good times and bad. But I haven't. Nevertheless, there are many lessons to be learned from such a story.

Focusing on the business model and how a company makes its money is key. ARM throws off cash, so hasn't needed to continually tap its shareholders for additional funds. Its share count has more or less doubled since it floated, though, presumably mostly due to acquisitions and share options.

And the best businesses often always seem expensive. When ARM joined the market, it was valued at around 80 times its latest annual profits. And it still is today.

Perhaps the most important lesson is that great business often give you many opportunities to buy them. In particular, you could have picked up ARM in 1998, 2003, and 2008 and earned supersized returns. Indeed, 2008, 10 years after it joined the market, was perhaps the best opportunity of all.

For more on how to pick the great shares of the future, I'd heartily recommended this free Motley Fool report on making a million in the stock market. Download it today and it's yours to keep.

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