Why Dunkin’ Brands Group, Inc.’s (NASDAQ:DNKN) High P/E Ratio Isn’t Necessarily A Bad Thing

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Dunkin’ Brands Group, Inc.’s (NASDAQ:DNKN) P/E ratio could help you assess the value on offer. Dunkin’ Brands Group has a price to earnings ratio of 21.20, based on the last twelve months. That means that at current prices, buyers pay $21.20 for every $1 in trailing yearly profits.

See our latest analysis for Dunkin’ Brands Group

How Do You Calculate A P/E Ratio?

The formula for P/E is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for Dunkin’ Brands Group:

P/E of 21.20 = $61.950 ÷ $2.923 (Based on the year to December 2019.)

(Note: the above calculation results may not be precise due to rounding.)

Is A High P/E Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each $1 the company has earned over the last year. All else being equal, it’s better to pay a low price — but as Warren Buffett said, ‘It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price’.

Does Dunkin’ Brands Group Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Dunkin’ Brands Group has a higher P/E than the average (14.0) P/E for companies in the hospitality industry.

NasdaqGS:DNKN Price Estimation Relative to Market, March 14th 2020
NasdaqGS:DNKN Price Estimation Relative to Market, March 14th 2020

That means that the market expects Dunkin’ Brands Group will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So further research is always essential. I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

Generally speaking the rate of earnings growth has a profound impact on a company’s P/E multiple. If earnings are growing quickly, then the ‘E’ in the equation will increase faster than it would otherwise. And in that case, the P/E ratio itself will drop rather quickly. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

Dunkin’ Brands Group increased earnings per share by 6.0% last year. And it has bolstered its earnings per share by 12% per year over the last five years.

Remember: P/E Ratios Don’t Consider The Balance Sheet

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

How Does Dunkin’ Brands Group’s Debt Impact Its P/E Ratio?

Net debt is 47% of Dunkin’ Brands Group’s market cap. You’d want to be aware of this fact, but it doesn’t bother us.

The Verdict On Dunkin’ Brands Group’s P/E Ratio

Dunkin’ Brands Group’s P/E is 21.2 which is above average (13.8) in its market. Given the debt is only modest, and earnings are already moving in the right direction, it’s not surprising that the market expects continued improvement.

When the market is wrong about a stock, it gives savvy investors an opportunity. As value investor Benjamin Graham famously said, ‘In the short run, the market is a voting machine but in the long run, it is a weighing machine. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

You might be able to find a better buy than Dunkin’ Brands Group. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.