What a fantastic six months it’s been for Arrow Electronics. Shares of the company have skyrocketed 68.9%, hitting $230.24. This was partly thanks to its solid quarterly results, and the run-up might have investors contemplating their next move.
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Why Is Arrow Electronics Not Exciting?
We’re happy investors have made money, but we don’t have much confidence in Arrow Electronics. Here are three reasons why there are better opportunities than ARW, plus one stock we’d rather own.
1. Long-Term Revenue Growth Disappoints
A company’s long-term sales performance can indicate its overall quality. Any business can put up a good quarter or two, but the best consistently grow over the long haul. Over the last five years, Arrow Electronics grew its sales at a sluggish 1.9% compounded annual growth rate. This fell short of our benchmarks.
2. Low Gross Margin Reveals Weak Structural Profitability
All else equal, we prefer higher gross margins because they make it easier to generate more operating profits and indicate that a company commands pricing power by offering more differentiated products.
Arrow Electronics has bad unit economics for an industrials business, signaling it operates in a competitive market. As you can see below, it averaged a 12.2% gross margin over the last five years. Said differently, Arrow Electronics had to pay a chunky $87.78 to its suppliers for every $100 in revenue.
3. New Investments Fail to Bear Fruit as ROIC Declines
We like to invest in businesses with high returns, but the trend in a company’s ROIC can also be an early indicator of future business quality.
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 isn’t a terrible business, but it doesn’t pass our quality test. Following the recent surge, the stock trades at 10.4× forward P/E (or $230.24 per share). While this valuation is fair, the upside isn’t great compared to the potential downside. We’re fairly confident there are better investments elsewhere. We’d recommend looking at the most entrenched endpoint security platform on the market.
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