Unpleasant Surprises Could Be In Store For McDonald's Holdings Company (Japan), Ltd.'s (TSE:2702) Shares

With a price-to-earnings (or "P/E") ratio of 36.5x McDonald's Holdings Company (Japan), Ltd. (TSE:2702) may be sending very bearish signals at the moment, given that almost half of all companies in Japan have P/E ratios under 14x and even P/E's lower than 9x are not unusual. 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.

Recent times have been advantageous for McDonald's Holdings Company (Japan) as its earnings have been rising faster than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.

View our latest analysis for McDonald's Holdings Company (Japan)

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Does Growth Match The High P/E?

The only time you'd be truly comfortable seeing a P/E as steep as McDonald's Holdings Company (Japan)'s is when the company's growth is on track to outshine the market decidedly.

Taking a look back first, we see that the company grew earnings per share by an impressive 26% last year. The latest three year period has also seen a 25% overall rise in EPS, aided extensively by its short-term performance. So we can start by confirming that the company has actually done a good job of growing earnings over that time.

Shifting to the future, estimates from the two analysts covering the company suggest earnings should grow by 11% per year over the next three years. Meanwhile, the rest of the market is forecast to expand by 11% per year, which is not materially different.

With this information, we find it interesting that McDonald's Holdings Company (Japan) is trading at a high P/E compared to the market. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.

The Key Takeaway

Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

We've established that McDonald's Holdings Company (Japan) currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. 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. Unless these conditions improve, it's challenging to accept these prices as being reasonable.

The company's balance sheet is another key area for risk analysis. Take a look at our free balance sheet analysis for McDonald's Holdings Company (Japan) with six simple checks on some of these key factors.

If these risks are making you reconsider your opinion on McDonald's Holdings Company (Japan), explore our interactive list of high quality stocks to get an idea of what else is out there.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.