I am writing today to help inform people who are new to the stock market and want a simplistic look at the return on Arrow Electronics Inc (NYSE:ARW) stock.
Buying Arrow Electronics makes you a partial owner of the company. This share represents a portion of capital used by the company to operate the business, and it is important the company is able to use the capital base efficiently to create adequate cash flows for you as an investor. Your return is tied to ARW’s ability to do this because the amount earned is used to invest in opportunities to grow the business or payout dividends, which are the two sources of return on investment. To understand Arrow Electronics’s capital returns we will look at a useful metric called return on capital employed. This will tell us if the company is growing your capital and placing you in good stead to sell your shares at a profit.
ROCE: Explanation and Calculation
When you choose to invest in a company, there is an opportunity cost because that money could’ve been invested elsewhere. Therefore all else aside, your investment in a certain company represents a vote of confidence that the money used to buy the stock will grow larger than if invested elsewhere. So the business’ ability to grow the size of your capital is very important and can be assessed by comparing the return on capital you can get on your investment with a hurdle rate that depends on the other return possibilities you can identify. To determine Arrow Electronics’s capital return we will use ROCE, which tells us how much the company makes from the capital employed in their operations (for things like machinery, wages etc). ARW’s ROCE is calculated below:
ROCE Calculation for ARW
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = US$977m ÷ (US$17b – US$7.8b) = 13%
The calculation above shows that ARW’s earnings were 13% of capital employed. This shows Arrow Electronics provides an uninspiring capital return that is slightly below the 15% ROCE that is typically considered to be a strong benchmark. Nevertheless, if ARW is clever with their reinvestments or dividend payments, investors can still grow their capital but may not see the same compounded performance as other high-returning companies.
Then why have investors invested?
Although Arrow Electronics is in an unfavourable position, you should know that this could change if the company is able to increase earnings on the same capital base or find new efficiencies that require less capital to produce earnings. So it is important for investors to understand what is going on under the hood and look at how these variables have been behaving. Looking at the past 3 year period shows us that ARW boosted investor return on capital employed from 12%. We can see that earnings have increased from US$771m to US$977m whilst capital employed improved as well albeit by a relatively smaller amount, signifying ROCE increased as a result of a greater surge in earnings compared to the business’ use of capital.
ROCE for ARW investors is below the desired level at the moment, however, the company has triggered an upward trend over the recent past which could signal an opportunity for a solid return on investment in the long term. It is important to know that ROCE does not dictate returns alone, so you need to consider other fundamentals in the business such as future prospects and valuation to determine whether there is potential for return by focusing our attention elsewhere. If you’re interested in diving deeper, take a look at what I’ve linked below for further information on these fundamentals and other potential investment opportunities.
- Future Outlook: What are well-informed industry analysts predicting for ARW’s future growth? Take a look at our free research report of analyst consensus for ARW’s outlook.
- Valuation: What is ARW worth today? Despite the unattractive ROCE, is the outlook correctly factored in to the price? The intrinsic value infographic in our free research report helps visualize whether ARW is currently undervalued by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.