Arrow Electronics, Inc.'s (NYSE:ARW) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?

Arrow Electronics (NYSE:ARW) has had a great run on the share market with its stock up by a significant 7.9% over the last month. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. In this article, we decided to focus on Arrow Electronics' ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Arrow Electronics

How Is ROE Calculated?

Return on equity can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Arrow Electronics is:

19% = US$976m ÷ US$5.2b (Based on the trailing twelve months to October 2021).

The 'return' is the amount earned after tax over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.19 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Arrow Electronics' Earnings Growth And 19% ROE

At first glance, Arrow Electronics seems to have a decent ROE. On comparing with the average industry ROE of 14% the company's ROE looks pretty remarkable. However, for some reason, the higher returns aren't reflected in Arrow Electronics' meagre five year net income growth average of 2.6%. This is generally not the case as when a company has a high rate of return it should usually also have a high earnings growth rate. A few likely reasons why this could happen is that the company could have a high payout ratio or the business has allocated capital poorly, for instance.

We then compared Arrow Electronics' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 14% in the same period, which is a bit concerning.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Arrow Electronics is trading on a high P/E or a low P/E, relative to its industry.

Is Arrow Electronics Making Efficient Use Of Its Profits?

Arrow Electronics doesn't pay any dividend currently which essentially means that it has been reinvesting all of its profits into the business. However, there's only been very little earnings growth to show for it. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Summary

Overall, we feel that Arrow Electronics certainly does have some positive factors to consider. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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.

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