Arm Holdings plc's (NASDAQ:ARM) Share Price Not Quite Adding Up

You may think that with a price-to-sales (or "P/S") ratio of 47.8x Arm Holdings plc (NASDAQ:ARM) is a stock to avoid completely, seeing as almost half of all the Semiconductor companies in the United States have P/S ratios under 4.2x and even P/S lower than 1.9x aren't out of the ordinary. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

See our latest analysis for Arm Holdings

What Does Arm Holdings' P/S Mean For Shareholders?

Recent times haven't been great for Arm Holdings as its revenue has been rising slower than most other companies. 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.

Is There Enough Revenue Growth Forecasted For Arm Holdings?

The only time you'd be truly comfortable seeing a P/S as steep as Arm Holdings' is when the company's growth is on track to outshine the industry decidedly.

If we review the last year of revenue growth, the company posted a terrific increase of 26%. The strong recent performance means it was also able to grow revenue by 37% in total over the last three years. 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 23% per year as estimated by the analysts watching the company. That's shaping up to be similar to the 25% per year growth forecast for the broader industry.

In light of this, it's curious that Arm Holdings' P/S sits above the majority of other companies. 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.

What Does Arm Holdings' P/S Mean For Investors?

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.

Seeing as its revenues are forecast to grow in line with the wider industry, it would appear that Arm Holdings currently trades on a higher than expected P/S. When we see revenue growth that just matches the industry, we don't expect elevates P/S figures to remain inflated for the long-term. A positive change is needed in order to justify the current price-to-sales ratio.

A lot of potential risks can sit within a company's balance sheet. Our free balance sheet analysis for Arm Holdings with six simple checks will allow you to discover any risks that could be an issue.

If strong companies turning a profit tickle your fancy, then you'll want to check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.