ASML Holdings (ASML) has delivered a strong year-to-date performance of over 36%. This growth has been a progression of an increase in share price that began in 2009. Since 2009, ASML has increased nearly 240%, and added around $14 billion in value to the firm. Through this article, I will explore the fundamental drivers of ASML, and present the case that the firm is overvalued and may experience a decrease in price in the future.
In order to thoroughly analyze ASML, I have relied heavily on two fundamental metrics: return on assets and return on equity. Return on assets is the net income of the company divided by average total assets. Return on assets tells the analyst how efficiently management uses its assets to generate profits. Return on equity is net income divided by directly invested shareholder equity. Return on equity informs the investor as to how successful management has been at generating a return for equity holders. The chart below shows three years of returns for ASML.
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The chart above shows the historic return on assets and return on equity for ASML. The first thing to notice is that there has been quite a bit of volatility associated with historic returns. Returns begin declining in 2009 to the point where the company began suffering losses during the second half of the year. Around 2010, however, ASML worked its way to profitability, and returns grew until the middle of 2011. In the second and third quarters of 2011, returns began to decline, and have been declining ever since.
The most immediate conclusion that can be drawn from the volatility in returns is that ASML tends to have a non-consistent competitive environment. For various unknowable reasons, ASML has fluctuated between periods of high profitability and low profitability. This volatility in returns should be reflected in the stock price. During periods in which a company is increasing its returns and, subsequently, its ability to compete, it should experience higher share prices due to the fact that investors tend to attempt to park capital in organizations that offer a healthy return on investment. The simple relationship of co-movement between returns and share price held true between the last part of 2009 and the middle of 2011. Between these years, returns strongly increased, and the market responded by increasing the share price by over 40%.
Beginning in the middle of 2011, however, a troubling relationship began to develop. Returns have been steadily decreasing since 2011, and share price has increased by an additional 50%. In my opinion, this represents a decoupling between the company's performance and share price. I believe that that this increase in price is due to speculative fervor. Investors have ignored the fact that the fundamental performance of the company is in decline, and have chosen instead to focus on speculation about future developments. In my opinion, investors who purchase shares in companies with declining fundamentals are exposing themselves to heightened levels of risk. Eventually, I believe that share price will decline in reflection of the fundamental condition of the company, and this is why I recommend shorting ASML.
Rather than immediately shorting the stock, I believe that investors should exercise patience and prudence. After all, ASML has increased over 150% during the past three years in a move that may not reverse for months to come. For this reason, I suggest that investors wait until prices actually begin to decline prior to initiating a short position. I believe that from a technical standpoint, the price will be in decline if it falls below $50 per share. If price falls below $50, it will have violated the support zone of $52 and broken the rising trend line. With these two barriers breached, I believe that a short is appropriate. In order to limit risk on this trade, I suggest that traders put an initial stop at $59 per share and work the stop downwards as price continues to decline.