Price to Sales Ratio
This an interesting case where the price to sales ratio of a share clearly demonstrated overvaluation of what we consider to be an excellent company – ARM Holdings.
ARM Holdings designs micro-processors; most of which are made under licence by someone else and end up in the ubiquitous smart phone. The firm has high profit margins, consistent growth in both revenue and earnings which has reward shareholders with a return of over 400% in the last 6 years………….whats not to like.
Well back in March 2015 I was looking at this share and the Price to Sales ratio in particular – price to sales is simply the current share price divided by the revenue per share, e.g. if you the price is £2.00 per share and the firm is generating £0.50 revenue per share the PS ratio is 4x).
Now lots of people are only really interested in the Price to Earnings Ratio – earnings being the net profit – but a lot can happen between the top of the Income Statement (sales) and the bottom (earnings). However if you want to look at a good reason for paying attention to the Price to Sales read what Scott Mcnealy said in 2002; I have mentioned it a few times, most recently in a round up in August last year .
Anyway back to ARM Holdings, image one is a chart that we produced back in March 2015 showing where the PS ratio was for ARM in relation to its long term average.
Image two is a chart of the share price of ARM and where it was in comparison to certain lows and highs in the PS ratio.
The results can be summarised as follows:
July 2012 – marked in green
- Share price 17/07/2012 £4.97
- PS ratio 13.61
- PS ratio 6.35% above long term average
- Current share price £9.53
- Return excluding dividends 89.73%
December 2013 – marked in red
- Share price 23/12/13 £11.06
- PS ratio 26.86x
- PS ratio 117% above long term average
- Current share price £9.53
- Return excluding dividends -13.83%
March – marked in red
- Share price 15/03/2015 £11.86
- PS ratio 21.50x
- PS ratio 50+% above long term average
- Current share price £9.53
- Return excluding dividends -19.65%
The moral of the story – buy a good Company at a good time!
