With a median price-to-earnings (or "P/E") ratio of close to 17x in the United States, you could be forgiven for feeling indifferent about Northrop Grumman Corporation's (NYSE:NOC) P/E ratio of 18.9x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.
Northrop Grumman certainly has been doing a good job lately as it's been growing earnings more than most other companies. One possibility is that the P/E is moderate because investors think this strong earnings performance might be about to tail off. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's not quite in favour.
See our latest analysis for Northrop Grumman
Does Growth Match The P/E?
Northrop Grumman's P/E ratio would be typical for a company that's only expected to deliver moderate growth, and importantly, perform in line with the market.
Retrospectively, the last year delivered an exceptional 77% gain to the company's bottom line. Despite this strong recent growth, it's still struggling to catch up as its three-year EPS frustratingly shrank by 29% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.
Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 7.5% each year over the next three years. Meanwhile, the rest of the market is forecast to expand by 10% per year, which is noticeably more attractive.
With this information, we find it interesting that Northrop Grumman is trading at a fairly similar P/E to the market. It seems most investors are ignoring the fairly limited growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.
The Bottom Line On Northrop Grumman's 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 Northrop Grumman's analyst forecasts revealed that its inferior earnings outlook isn't impacting its P/E as much as we would have predicted. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the moderate P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.
Plus, you should also learn about these 2 warning signs we've spotted with Northrop Grumman.
Of course, you might also be able to find a better stock than Northrop Grumman. 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.