With a price-to-earnings (or "P/E") ratio of 23.9x General Dynamics Corporation (NYSE:GD) may be sending bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 18x and even P/E's lower than 10x are not unusual. 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, General Dynamics 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.
Does Growth Match The High P/E?
There's an inherent assumption that a company should outperform the market for P/E ratios like General Dynamics' to be considered reasonable.
Retrospectively, the last year delivered a decent 5.4% gain to the company's bottom line. The latest three year period has also seen a 12% overall rise in EPS, aided somewhat by its short-term performance. Accordingly, shareholders would have probably been satisfied with the medium-term rates of earnings growth.
Turning to the outlook, the next three years should generate growth of 13% per year as estimated by the analysts watching the company. Meanwhile, the rest of the market is forecast to only expand by 10% each year, which is noticeably less attractive.
With this information, we can see why General Dynamics is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.
The Bottom Line On General Dynamics' P/E
Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.
We've established that General Dynamics maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. It's hard to see the share price falling strongly in the near future under these circumstances.
The company's balance sheet is another key area for risk analysis. Take a look at our free balance sheet analysis for General Dynamics with six simple checks on some of these key factors.
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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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.
