When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") above 20x, you may consider Arcos Dorados Holdings Inc. (NYSE:ARCO) as an attractive investment with its 12.1x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.

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.

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Does Growth Match The Low P/E?

In order to justify its P/E ratio, Arcos Dorados Holdings would need to produce sluggish growth that's trailing the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 19%. Still, the latest three year period has seen an excellent 564% overall rise in EPS, in spite of its unsatisfying short-term performance. So we can start by confirming that the company has generally done a very good job of growing earnings over that time, even though it had some hiccups along the way.

Turning to the outlook, the next year should generate growth of 12% as estimated by the eight analysts watching the company. That's shaping up to be materially lower than the 15% growth forecast for the broader market.

In light of this, it's understandable that Arcos Dorados Holdings' P/E sits below the majority of other companies. Apparently many shareholders weren't comfortable holding on while the company is potentially eyeing a less prosperous future.

The Key Takeaway

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 maintains its low P/E on the weakness of its forecast growth being lower than the wider market, as expected. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

You need to take note of risks, for example - Arcos Dorados Holdings has 3 warning signs (and 1 which shouldn't be ignored) we think you should know about.

Of course, you might also be able to find a better stock than Arcos Dorados Holdings. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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