McDonald's Corporation's (NYSE:MCD) Share Price Could Signal Some Risk

When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 16x, you may consider McDonald's Corporation (NYSE:MCD) as a stock to avoid entirely with its 26.1x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

With its earnings growth in positive territory compared to the declining earnings of most other companies, McDonald's has been doing quite well of late. The P/E is probably high because investors think the company will continue to navigate the broader market headwinds better than most. If not, then existing shareholders might be a little nervous about the viability of the share price.

See our latest analysis for McDonald's

Keen to find out how analysts think McDonald's' future stacks up against the industry? In that case, our free report is a great place to start.

Is There Enough Growth For McDonald's?

In order to justify its P/E ratio, McDonald's would need to produce outstanding growth well in excess of the market.

Retrospectively, the last year delivered an exceptional 43% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 74% in total over the last three years. So we can start by confirming that the company has done a great job of growing earnings over that time.

Looking ahead now, EPS is anticipated to climb by 9.1% per year during the coming three years according to the analysts following the company. That's shaping up to be materially lower than the 12% per annum growth forecast for the broader market.

In light of this, it's alarming that McDonald's' P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.

The Final Word

While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

Our examination of McDonald's' analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near as much as we would have predicted. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

You should always think about risks. Case in point, we've spotted 2 warning signs for McDonald's you should be aware of.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.