BAE Systems plc (LON:BA.) Investors Are Less Pessimistic Than Expected

With a price-to-earnings (or "P/E") ratio of 21.6x BAE Systems plc (LON:BA.) may be sending bearish signals at the moment, given that almost half of all companies in the United Kingdom have P/E ratios under 16x and even P/E's lower than 10x are not unusual. 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, BAE Systems' earnings have gone into reverse gear, which is not great. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. If not, then existing shareholders may be extremely nervous about the viability of the share price.

View our latest analysis for BAE Systems

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How Is BAE Systems' Growth Trending?

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

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 3.7%. That put a dampener on the good run it was having over the longer-term as its three-year EPS growth is still a noteworthy 11% in total. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been mostly respectable for the company.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 11% per year over the next three years. With the market predicted to deliver 15% growth per annum, the company is positioned for a weaker earnings result.

With this information, we find it concerning that BAE Systems is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

What We Can Learn From BAE Systems' P/E?

While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

We've established that BAE Systems currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

It is also worth noting that we have found 1 warning sign for BAE Systems that you need to take into consideration.

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.

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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.