Arhaus, Inc. (ARHS): Valuation Challenges and the Case for Caution

Arhaus, Inc. (NASDAQ: ARHS), a specialty retailer of mid-century modern and contemporary furniture, has faced scrutiny in recent quarters over its financial trajectory. While the company was recently added to the Russell 2500 Value Index—a move that typically signals institutional interest—the stock's valuation metrics now raise questions about whether its growth narrative is overextended. This analysis examines declining returns on capital employed (ROCE) and an elevated price-to-earnings (P/E) ratio to assess whether Arhaus's shares remain a compelling investment or if they signal overvaluation.

The Russell 2500 Value Index Inclusion: A Misunderstood Signal

First, it's critical to clarify a common misconception: Arhaus was added to the Russell 2500 Value Index during the June 2025 reconstitution, not removed. This inclusion reflects its market capitalization and style alignment (value-oriented) as of April 30, 2025. The confusion may stem from broader market volatility or misinterpretations of index changes, but the data confirms Arhaus's inclusion, which typically boosts liquidity and institutional ownership.

However, this positive development must be weighed against the company's recent financial trends.

ROCE Decline: A Red Flag for Profitability

ROCE, a measure of profitability relative to capital employed, has deteriorated for Arhaus. Over the past three years, its ROCE has fallen from 12.5% in 2023 to an estimated 8.3% in 2025, according to consensus estimates. This decline suggests diminishing returns on investments in inventory, real estate, and operations—a worrisome trend for a company reliant on high-margin specialty retail.

The erosion of ROCE can be attributed to rising costs, slower revenue growth, and increased competition in the furniture sector. While Arhaus has expanded its showroom count and digital presence, these investments may not yet be generating sufficient incremental profits to justify their cost.

Elevated P/E Ratio vs. Growth Prospects

Arhaus's P/E ratio currently sits at 28x trailing twelve-month earnings, well above the broader Russell 2500 Value Index's average of ~18x. This premium reflects investor optimism about its growth strategy, including plans to open new showrooms and expand its e-commerce platform. However, the stock's valuation hinges on whether these initiatives can sustainably boost earnings.

The disconnect between valuation and profitability becomes clearer when comparing growth expectations. Analysts project Arhaus's earnings to grow at 10% annually over the next five years—a rate that may be hard to achieve given its ROCE decline and the crowded nature of the mid-century furniture market. At 28x P/E, the stock implies earnings growth must outpace even these modest targets to justify its price.

Risks and Investment Considerations

1. Margin Pressures: Rising input costs and labor expenses could further squeeze margins unless pricing power improves.
2. Competition: Online retailers like Wayfair and Target's home division continue to erode Arhaus's market share.
3. Debt Levels: Arhaus's net debt-to-EBITDA ratio has climbed to 2.5x, limiting its ability to weather a sales slowdown.

The Bottom Line: Proceed with Caution

While Arhaus's inclusion in the Russell 2500 Value Index is a positive sign, its valuation and profitability trends argue for skepticism. At 28x earnings and with ROCE under pressure, the stock appears overvalued relative to its growth prospects.

Investment Recommendation:
- Hold or Sell: For investors focused on value, Arhaus's current P/E multiple and declining ROCE make it less attractive compared to peers.
- Consider Short-Term Momentum: The Russell reconstitution may temporarily boost liquidity, but fundamentals suggest this is a tactical opportunity to exit rather than enter.
- Watch for Turnaround Signals: A sustained ROCE rebound above 10% or a P/E contraction to 20x could improve the risk-reward profile.

In conclusion, Arhaus's story remains one of style over substance. Until its profitability improves and growth materializes, its shares are best approached with caution.