With a price-to-earnings (or "P/E") ratio of 32.6x 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 17x and even P/E's lower than 9x 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 so lofty.
Recent times haven't been advantageous for Northrop Grumman as its earnings have been falling quicker 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.
What Are Growth Metrics Telling Us About The High P/E?
In order to justify its P/E ratio, Northrop Grumman would need to produce outstanding growth well in excess of the market.
Retrospectively, the last year delivered a frustrating 57% decrease to the company's bottom line. As a result, earnings from three years ago have also fallen 28% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.
Turning to the outlook, the next three years should generate growth of 29% per year as estimated by the analysts watching the company. That's shaping up to be materially higher than the 12% per annum growth forecast for the broader market.
In light of this, it's understandable that Northrop Grumman's P/E sits above the majority of other companies. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.
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 Northrop Grumman 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.
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 you're unsure about the strength of Northrop Grumman's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.
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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.