Yum! Brands, Inc.'s (NYSE:YUM) Share Price Not Quite Adding Up

Yum! Brands, Inc.'s (NYSE:YUM) price-to-earnings (or "P/E") ratio of 24.1x might make it look like a sell right now compared to the market in the United States, where around half of the companies have P/E ratios below 17x and even P/E's below 10x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's as high as it is.

With its earnings growth in positive territory compared to the declining earnings of most other companies, Yum! Brands has been doing quite well of late. It seems that many are expecting the company to continue defying the broader market adversity, which has increased investors’ willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See 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.

Does Growth Match The High P/E?

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

If we review the last year of earnings growth, the company posted a worthy increase of 10%. EPS has also lifted 25% in aggregate from three years ago, partly thanks to the last 12 months of growth. Therefore, it's fair to say the earnings growth recently has been respectable for the company.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 11% per annum over the next three years. Meanwhile, the rest of the market is forecast to expand by 10% per annum, which is not materially different.

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. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.

What We Can Learn From Yum! Brands' P/E?

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 Yum! Brands 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. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 4 warning signs with Yum! Brands (at least 2 which are a bit unpleasant), and understanding them should be part of your investment process.

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.