Arm Holdings plc's (NASDAQ:ARM) 30% Share Price Plunge Could Signal Some Risk

To the annoyance of some shareholders, Arm Holdings plc (NASDAQ:ARM) shares are down a considerable 30% in the last month, which continues a horrid run for the company. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 30% in that time.

Even after such a large drop in price, when almost half of the companies in the United States' Semiconductor industry have price-to-sales ratios (or "P/S") below 2.7x, you may still consider Arm Holdings as a stock not worth researching with its 25x P/S ratio. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's so lofty.

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Check out our latest analysis for Arm Holdings

How Has Arm Holdings Performed Recently?

Arm Holdings could be doing better as it's been growing revenue less than most other companies lately. One possibility is that the P/S ratio is high because investors think this lacklustre revenue performance will improve markedly. However, if this isn't the case, investors might get caught out paying too much for the stock.

Keen to find out how analysts think Arm Holdings' future stacks up against the industry? In that case, our free report is a great place to start .

Do Revenue Forecasts Match The High P/S Ratio?

Arm Holdings' P/S ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the industry.

Retrospectively, the last year delivered an exceptional 26% gain to the company's top line. The latest three year period has also seen an excellent 37% overall rise in revenue, aided by its short-term performance. So we can start by confirming that the company has done a great job of growing revenue over that time.

Turning to the outlook, the next three years should generate growth of 22% per annum as estimated by the analysts watching the company. With the industry predicted to deliver 24% growth per year, the company is positioned for a comparable revenue result.

With this in consideration, we find it intriguing that Arm Holdings' P/S is higher than its industry peers. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for disappointment if the P/S falls to levels more in line with the growth outlook.

The Key Takeaway

Even after such a strong price drop, Arm Holdings' P/S still exceeds the industry median significantly. Generally, our preference is to limit the use of the price-to-sales ratio to establishing what the market thinks about the overall health of a company.

Analysts are forecasting Arm Holdings' revenues to only grow on par with the rest of the industry, which has lead to the high P/S ratio being unexpected. Right now we are uncomfortable with the relatively high share price as the predicted future revenues aren't likely to support such positive sentiment for long. A positive change is needed in order to justify the current price-to-sales ratio.

The company's balance sheet is another key area for risk analysis. Our free balance sheet analysis for Arm Holdings with six simple checks will allow you to discover any risks that could be an issue.

Of course, profitable companies with a history of great earnings growth are generally safer bets. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.