Arrow Electronics, Inc.'s (NYSE:ARW) price-to-earnings (or "P/E") ratio of 7.4x might make it look like a strong buy right now compared to the market in the United States, where around half of the companies have P/E ratios above 17x and even P/E's above 33x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so limited.
With earnings that are retreating more than the market's of late, Arrow Electronics has been very sluggish. The P/E is probably low because investors think this poor earnings performance isn't going to improve at all. You'd much rather the company wasn't bleeding earnings if you still believe in the business. If not, then existing shareholders will probably struggle to get excited about the future direction of the share price.
What Are Growth Metrics Telling Us About The Low P/E?
In order to justify its P/E ratio, Arrow Electronics would need to produce anemic growth that's substantially trailing the market.
Retrospectively, the last year delivered a frustrating 27% decrease to the company's bottom line. Still, the latest three year period has seen an excellent 123% overall rise in EPS, in spite of its unsatisfying short-term performance. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been more than adequate for the company.
Shifting to the future, estimates from the eight analysts covering the company suggest earnings growth is heading into negative territory, declining 39% over the next year. Meanwhile, the broader market is forecast to expand by 11%, which paints a poor picture.
With this information, we are not surprised that Arrow Electronics is trading at a P/E lower than the market. However, shrinking earnings are unlikely to lead to a stable P/E over the longer term. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.
The Final Word
We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.
As we suspected, our examination of Arrow Electronics' analyst forecasts revealed that its outlook for shrinking earnings is contributing to its low P/E. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. It's hard to see the share price rising strongly in the near future under these circumstances.
You should always think about risks. Case in point, we've spotted 3 warning signs for Arrow Electronics you should be aware of, and 2 of them are a bit unpleasant.
You might be able to find a better investment than Arrow Electronics. If you want a selection of possible candidates, 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.