With a price-to-earnings (or "P/E") ratio of 30.2x Northrop Grumman Corporation (NYSE:NOC) may be sending very bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 16x and even P/E's lower than 9x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

Northrop Grumman 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Is There Enough Growth For Northrop Grumman?

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

Retrospectively, the last year delivered a frustrating 54% decrease to the company's bottom line. This means it has also seen a slide in earnings over the longer-term as EPS is down 46% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 27% per year over the next three years. Meanwhile, the rest of the market is forecast to only expand by 9.9% per annum, which is noticeably less attractive.

In light of this, it's understandable that Northrop Grumman's P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Final Word

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.

As we suspected, our examination of Northrop Grumman's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. It's hard to see the share price falling strongly in the near future under these circumstances.

Don't forget that there may be other risks. For instance, we've identified 2 warning signs for Northrop Grumman that you should be aware of.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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