Those holding Arm Holdings plc (NASDAQ:ARM) shares would be relieved that the share price has rebounded 28% in the last thirty days, but it needs to keep going to repair the recent damage it has caused to investor portfolios. Longer-term shareholders would be thankful for the recovery in the share price since it's now virtually flat for the year after the recent bounce.

After such a large jump in price, Arm Holdings may be sending strong sell signals at present with a price-to-sales (or "P/S") ratio of 44x, when you consider almost half of the companies in the Semiconductor industry in the United States have P/S ratios under 5.1x and even P/S lower than 1.9x aren't out of the ordinary. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

What Does Arm Holdings' Recent Performance Look Like?

With revenue growth that's inferior to most other companies of late, Arm Holdings has been relatively sluggish. Perhaps the market is expecting future revenue performance to undergo a reversal of fortunes, which has elevated the P/S ratio. However, if this isn't the case, investors might get caught out paying too much for the stock.

Do Revenue Forecasts Match The High P/S Ratio?

In order to justify its P/S ratio, Arm Holdings would need to produce outstanding growth that's well in excess of the industry.

Retrospectively, the last year delivered an exceptional 21% gain to the company's top line. Pleasingly, revenue has also lifted 59% in aggregate from three years ago, thanks to the last 12 months of growth. So we can start by confirming that the company has done a great job of growing revenue over that time.

Looking ahead now, revenue is anticipated to climb by 21% each year during the coming three years according to the analysts following the company. With the industry predicted to deliver 26% growth each year, the company is positioned for a weaker revenue result.

With this information, we find it concerning that Arm Holdings is trading at a P/S higher than the industry. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. There's a good chance these shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with the growth outlook.

The Bottom Line On Arm Holdings' P/S

Shares in Arm Holdings have seen a strong upwards swing lately, which has really helped boost its P/S figure. We'd say the price-to-sales ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

It comes as a surprise to see Arm Holdings trade at such a high P/S given the revenue forecasts look less than stellar. When we see a weak revenue outlook, we suspect the share price faces a much greater risk of declining, bringing back down the P/S figures. At these price levels, investors should remain cautious, particularly if things don't improve.

Plus, you should also learn about this 1 warning sign we've spotted with Arm Holdings.

If companies with solid past earnings growth is up your alley, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.