This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll show how you can use Lockheed Martin Corporation’s (NYSE:LMT) P/E ratio to inform your assessment of the investment opportunity. Lockheed Martin has a P/E ratio of 24.26, based on the last twelve months. In other words, at today’s prices, investors are paying $24.26 for every $1 in prior year profit.
How Do You Calculate Lockheed Martin’s P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Lockheed Martin:
P/E of 24.26 = $256.55 ÷ $10.58 (Based on the trailing twelve months to September 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each $1 the company has earned over the last year. All else being equal, it’s better to pay a low price — but as Warren Buffett said, ‘It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.’
How Growth Rates Impact P/E Ratios
When earnings fall, the ‘E’ decreases, over time. That means even if the current P/E is low, it will increase over time if the share price stays flat. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
Lockheed Martin shrunk earnings per share by 14% over the last year. And over the longer term (3 years) earnings per share have decreased 4.7% annually. This might lead to low expectations.
How Does Lockheed Martin’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. You can see in the image below that the average P/E (18.9) for companies in the aerospace & defense industry is lower than Lockheed Martin’s P/E.
Its relatively high P/E ratio indicates that Lockheed Martin shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn’t guaranteed. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
Don’t forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
Lockheed Martin’s Balance Sheet
Net debt totals 19% of Lockheed Martin’s market cap. It would probably deserve a higher P/E ratio if it was net cash, since it would have more options for growth.
The Bottom Line On Lockheed Martin’s P/E Ratio
Lockheed Martin has a P/E of 24.3. That’s higher than the average in the US market, which is 15.8. With a bit of debt, but a lack of recent growth, it’s safe to say the market is expecting improved profit performance from the company, in the next few years.
Investors should be looking to buy stocks that the market is wrong about. As value investor Benjamin Graham famously said, ‘In the short run, the market is a voting machine but in the long run, it is a weighing machine.’ So this free visual report on analyst forecasts could hold they key to an excellent investment decision.
But note: Lockheed Martin may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.