General Dynamics Corporation's (NYSE:GD) price-to-earnings (or "P/E") ratio of 21x might make it look like a sell right now compared to the market in the United States, where around half of the companies have P/E ratios below 16x and even P/E's below 9x are quite common. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

While the market has experienced earnings growth lately, General Dynamics' earnings have gone into reverse gear, which is not great. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be extremely nervous about the viability of the share price.

Check out our latest analysis for General Dynamics

Is There Enough Growth For General Dynamics?

The only time you'd be truly comfortable seeing a P/E as high as General Dynamics' is when the company's growth is on track to outshine the market.

Taking a look back first, we see that there was hardly any earnings per share growth to speak of for the company over the past year. Still, the latest three year period was better as it's delivered a decent 9.4% overall rise in EPS. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.

Looking ahead now, EPS is anticipated to climb by 13% per annum during the coming three years according to the analysts following the company. That's shaping up to be similar to the 13% per year growth forecast for the broader market.

In light of this, it's curious that General Dynamics' P/E sits above the majority of other companies. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for disappointment if the P/E falls to levels more in line with the growth outlook.

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.

Our examination of General Dynamics' analyst forecasts revealed that its market-matching earnings outlook isn't impacting its high P/E as much as we would have predicted. When we see an average earnings outlook with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve, it's challenging to accept these prices as being reasonable.

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.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.