With a price-to-earnings (or "P/E") ratio of 26x McCormick & Company, Incorporated (NYSE:MKC) may be sending bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 17x and even P/E's lower than 10x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

McCormick certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. 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.

Does Growth Match The High P/E?

In order to justify its P/E ratio, McCormick would need to produce impressive growth in excess of the market.

If we review the last year of earnings growth, the company posted a worthy increase of 5.6%. Ultimately though, it couldn't turn around the poor performance of the prior period, with EPS shrinking 2.3% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 8.2% per year during the coming three years according to the analysts following the company. Meanwhile, the rest of the market is forecast to expand by 10% per annum, which is not materially different.

In light of this, it's curious that McCormick's P/E sits above the majority of other companies. 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 Bottom Line On McCormick's P/E

It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

We've established that McCormick currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. Right now we are uncomfortable with the relatively high share price as the predicted future earnings aren't likely to support such positive sentiment for long. Unless these conditions improve, it's challenging to accept these prices as being reasonable.

It is also worth noting that we have found 1 warning sign for McCormick that you need to take into consideration.

Of course, you might also be able to find a better stock than McCormick. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.

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