Take Care Before Diving Into The Deep End On Arcos Dorados Holdings Inc. (NYSE:ARCO)

Arcos Dorados Holdings Inc.'s (NYSE:ARCO) price-to-earnings (or "P/E") ratio of 11.3x might make it look like a 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 32x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.

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While the market has experienced earnings growth lately, Arcos Dorados Holdings' earnings have gone into reverse gear, which is not great. The P/E is probably low because investors think this poor earnings performance isn't going to get any better. If this is the case, then existing shareholders will probably struggle to get excited about the future direction of the share price.

View our latest analysis for Arcos Dorados Holdings

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Does Growth Match The Low P/E?

There's an inherent assumption that a company should underperform the market for P/E ratios like Arcos Dorados Holdings' to be considered reasonable.

Retrospectively, the last year delivered a frustrating 18% decrease to the company's bottom line. However, a few very strong years before that means that it was still able to grow EPS by an impressive 227% in total over the last three years. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 11% per year as estimated by the eight analysts watching the company. Meanwhile, the rest of the market is forecast to expand by 11% each year, which is not materially different.

With this information, we find it odd that Arcos Dorados Holdings is trading at a P/E lower than the market. It may be that most investors are not convinced the company can achieve future growth expectations.

The Bottom Line On Arcos Dorados Holdings' P/E

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.

We've established that Arcos Dorados Holdings currently trades on a lower than expected P/E since its forecast growth is in line with the wider market. When we see an average earnings outlook with market-like growth, we assume potential risks are what might be placing pressure on the P/E ratio. At least the risk of a price drop looks to be subdued, but investors seem to think future earnings could see some volatility.

There are also other vital risk factors to consider before investing and we've discovered 2 warning signs for Arcos Dorados Holdings that you should be aware of.

If you're unsure about the strength of Arcos Dorados Holdings' business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.