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General Dynamics Corporation's (NYSE:GD) Share Price Could Signal Some Risk

When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 13x, you may consider General Dynamics Corporation (NYSE:GD) as a stock to potentially avoid with its 18.4x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

Recent times haven't been advantageous for General Dynamics as its earnings have been rising slower than most other companies. One possibility is that the P/E is high because investors think this lacklustre earnings performance will improve markedly. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for General Dynamics

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If you'd like to see what analysts are forecasting going forward, you should check out our free report on 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 the company managed to grow earnings per share by a handy 3.4% last year. The solid recent performance means it was also able to grow EPS by 5.9% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been respectable for the company.

Turning to the outlook, the next three years should generate growth of 11% per year as estimated by the analysts watching the company. With the market predicted to deliver 9.6% growth per year, the company is positioned for a comparable earnings result.

With this information, we find it interesting that General Dynamics is trading at a high P/E compared to the market. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.

The Key Takeaway

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.

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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with General Dynamics, and understanding them should be part of your investment process.

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 P/E below 20x.

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.

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