Pinning Down BAE Systems plc's (LON:BA.) P/E Is Difficult Right Now

When close to half the companies in the United Kingdom have price-to-earnings ratios (or "P/E's") below 15x, you may consider BAE Systems plc (LON:BA.) as a stock to potentially avoid with its 18.8x 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.

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.

See our latest analysis for BAE Systems

Keen to find out how analysts think BAE Systems' future stacks up against the industry? In that case, our free report is a great place to start.

Is There Enough Growth For BAE Systems?

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.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune 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.

Turning to the outlook, the next three years should generate growth of 11% per year as estimated by the analysts watching the company. That's shaping up to be materially lower than the 14% each year growth forecast for the broader market.

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.

The Key Takeaway

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 BAE Systems' analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near 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 high P/E lower. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

And what about other risks? Every company has them, and we've spotted 1 warning sign for BAE Systems you should know about.

If you're unsure about the strength of BAE Systems' business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.