When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 18x, you may consider Starbucks Corporation (NASDAQ:SBUX) as a stock to avoid entirely with its 34.5x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

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Starbucks hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be extremely nervous about the viability of the share price.

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Does Growth Match The High P/E?

There's an inherent assumption that a company should far outperform the market for P/E ratios like Starbucks' to be considered reasonable.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 24%. As a result, earnings from three years ago have also fallen 27% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 16% per annum over the next three years. With the market only predicted to deliver 10% each year, the company is positioned for a stronger earnings result.

In light of this, it's understandable that Starbucks' P/E sits above the majority of other companies. Apparently shareholders aren't keen to offload something that is potentially eyeing a more 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 Starbucks maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.

We don't want to rain on the parade too much, but we did also find 3 warning signs for Starbucks (1 is concerning!) that you need to be mindful of.

If you're unsure about the strength of Starbucks' business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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