When close to half the companies in the United States have price-to-earnings ratios (or “P/E’s”) below 18x, you may consider Dunkin’ Brands Group, Inc. (NASDAQ:DNKN) as a stock to avoid entirely with its 29x 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.
Dunkin’ Brands Group has been struggling lately as its earnings have declined faster than most other companies. It might be that many expect the dismal earnings performance to recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be very nervous about the viability of the share price.
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Is There Enough Growth For Dunkin’ Brands Group?
In order to justify its P/E ratio, Dunkin’ Brands Group would need to produce outstanding growth well in excess of the market.
If we review the last year of earnings, dishearteningly the company’s profits fell to the tune of 5.4%. This has soured the latest three-year period, which nevertheless managed to deliver a decent 18% overall rise in EPS. Although it’s been a bumpy ride, it’s still fair to say the earnings growth recently has been mostly respectable for the company.
Turning to the outlook, the next three years should generate growth of 7.9% per annum as estimated by the analysts watching the company. With the market predicted to deliver 13% growth each year, the company is positioned for a weaker earnings result.
With this information, we find it concerning that Dunkin’ Brands Group is trading at a P/E higher than the market. It seems most investors are hoping for a turnaround in the company’s business prospects, but the analyst cohort is not so confident this will happen. There’s a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.
The Final Word
Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.
We’ve established that Dunkin’ Brands Group currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. 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 3 warning signs for Dunkin’ Brands Group you should be aware of, and 1 of them is concerning.
If these risks are making you reconsider your opinion on Dunkin’ Brands Group, explore our interactive list of high quality stocks to get an idea of what else is out there.
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. 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.
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