When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 16x, you may consider Yum! Brands, Inc. (NYSE:YUM) as a stock to avoid entirely with its 27.4x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

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Yum! Brands could be doing better as its earnings have been going backwards lately while most other companies have been seeing positive earnings growth. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for Yum! Brands

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Yum! Brands.

Is There Enough Growth For Yum! Brands?

Yum! Brands' P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.

Retrospectively, the last year delivered a frustrating 7.3% decrease to the company's bottom line. This has erased any of its gains during the last three years, with practically no change in EPS being achieved in total. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 12% per annum over the next three years. That's shaping up to be similar to the 11% per year growth forecast for the broader market.

With this information, we find it interesting that Yum! Brands is trading at a high P/E compared to the market. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for disappointment if the P/E falls to levels more in line with the growth outlook.

The Final Word

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.

Our examination of Yum! Brands' analyst forecasts revealed that its market-matching earnings outlook isn't impacting its high P/E as much as we would have predicted. When we see an average earnings outlook with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

Having said that, be aware Yum! Brands is showing 4 warning signs in our investment analysis, and 2 of those shouldn't be ignored.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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