Over the past six months, Arrow Electronics’s shares (currently trading at $113.01) have posted a disappointing 10.8% loss, well below the S&P 500’s 5.3% gain. This was partly driven by its softer quarterly results and may have investors wondering how to approach the situation.

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Despite the more favorable entry price, we don't have much confidence in Arrow Electronics. Here are three reasons why we avoid ARW and a stock we'd rather own.

Why Do We Think Arrow Electronics Will Underperform?

Founded as a single retail store, Arrow Electronics (NYSE:ARW) provides electronic components and enterprise computing solutions to businesses globally.

1. Long-Term Revenue Growth Flatter Than a Pancake

Examining a company’s long-term performance can provide clues about its quality. Any business can put up a good quarter or two, but the best consistently grow over the long haul. Unfortunately, Arrow Electronics struggled to consistently increase demand as its $28.49 billion of sales for the trailing 12 months was close to its revenue five years ago. This was below our standards and is a sign of poor business quality.

2. Low Gross Margin Reveals Weak Structural Profitability

At StockStory, we prefer high gross margin businesses because they indicate the company has pricing power or differentiated products, giving it a chance to generate higher operating profits.

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. That means Arrow Electronics paid its suppliers a lot of money ($87.80 for every $100 in revenue) to run its business.

3. EPS Barely Growing

Analyzing the long-term change in earnings per share (EPS) shows whether a company's incremental sales were profitable – for example, revenue could be inflated through excessive spending on advertising and promotions.

Arrow Electronics’s EPS grew at an unimpressive 8% compounded annual growth rate over the last five years. On the bright side, this performance was better than its flat revenue and tells us management responded to softer demand by adapting its cost structure.

Final Judgment

Arrow Electronics doesn’t pass our quality test. Following the recent decline, the stock trades at 8.5× forward price-to-earnings (or $113.01 per share). While this valuation is optically cheap, the potential downside is huge given its shaky fundamentals. There are superior stocks to buy right now. Let us point you toward Uber, whose profitability just reached an inflection point.

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