Although Arrow Electronics (currently trading at $120.07 per share) has gained 11.4% over the last six months, it has trailed the S&P 500’s 24.7% return during that period. This might have investors contemplating their next move.
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Why Do We Think Arrow Electronics Will Underperform?
We're sitting this one out for now. Here are three reasons we avoid ARW and a stock we'd rather own.
1. Long-Term Revenue Growth Flatter Than a Pancake
Examining a company’s long-term performance can provide clues about its quality. Any business can have short-term success, but a top-tier one grows for years. Unfortunately, Arrow Electronics struggled to consistently increase demand as its $28.5 billion of sales for the trailing 12 months was close to its revenue five years ago. This was below our standards and is a sign of poor business quality.
2. EPS Barely Growing
Analyzing the long-term change in earnings per share (EPS) shows whether a company's incremental sales were profitable – for example, revenue could be inflated through excessive spending on advertising and promotions.
Arrow Electronics’s EPS grew at an unimpressive 7.7% compounded annual growth rate over the last five years. On the bright side, this performance was better than its flat revenue and tells us management responded to softer demand by adapting its cost structure.
3. New Investments Fail to Bear Fruit as ROIC Declines
ROIC, or return on invested capital, is a metric showing how much operating profit a company generates relative to the money it has raised (debt and equity).
We like to invest in businesses with high returns, but the trend in a company’s ROIC is what often surprises the market and moves the stock price. Over the last few years, Arrow Electronics’s ROIC has unfortunately decreased. We like what management has done in the past, but its declining returns are perhaps a symptom of fewer profitable growth opportunities.
Final Judgment
Arrow Electronics falls short of our quality standards. With its shares underperforming the market lately, the stock trades at 9.8× forward P/E (or $120.07 per share). While this valuation is optically cheap, the potential downside is huge given its shaky fundamentals. There are better stocks to buy right now. We’d suggest looking at a safe-and-steady industrials business benefiting from an upgrade cycle.
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