Should You Sell General Dynamics Corporation (NYSE:GD) At This PE Ratio?

The current price of GD places the company at a discounted trailing PE of 18.78x, slightly lower than the 21.91x average multiple of the Aerospace & Defense. However, a static multiple such as PE is never conclusive on its own. This is because there are many company-specific factors like future prospects and capital structure, which are unaccounted for. To resolve this problem, I’ll identify some important factors to consider when judging the relative valuation of GD. Let's dive in.

Is GD making any money?

PE is only used when a company is profitable, such as GD. This is because companies that are unprofitable or have recently become loss making cannot be valued using price-to-earnings since there are no earnings. Other useful measures can be employed to evaluate companies in this situation, such as price-to-free-cash-flow or price-to-sales where it is suitable. GD’s previous earnings record has seen negative numbers, until 2013 saw a breakeven period with earnings of US$2.49b, followed by the most recent bottom-line of US$2.95b. This means investors can draw some insight from using the PE ratio, but let’s see if there is a better alternative.

Is GD in a lot of debt?

Generally, debt should be below 40% of equity. Given that ’s debt-to-equity ratio is currently 55.03%, there’s room for improvement. This ratio indicates that for every $1 you invest, the company owes $0.55 to debtors. This means that if the company were to go bankrupt, equity investors have a lower claim on assets than debt providers that is owed the lion’s share of assets. Though this is an unlikely scenario for a US$56.08b company.

You may be wondering how debt impacts an equity valuation. Well, the company’s share price theoretically represents the value of its equity portion only. However, it’s crucial to account for debt as well, since debt represents a liability to the owner, and it impacts the earnings capacity and risk profile of the company. The EV/EBITDA multiple, which uses EV as a substitute for share price, allows us to incorporate debt into our valuation. The 12.72x average multiple for the industry indicates that GD may be valued fairly, which differs from the undervaluation GD’s PE ratio suggested.

Does GD have a fast-growing outlook?

According to consensus estimates, earnings are expected to compound at 9.66% every year for the next 5 years. This gives GD a robust growth trajectory for the future. The issue with using current earnings in the denominator of a multiple is that it doesn’t reflect this expected growth, which is a setback for trailing multiples. Since a stock’s value should be reflective of future earnings, not the past, it may be best to use upcoming earnings as the denominator. To account for this growth we can use the one-year analyst-consensus future EBITDA (this is a “forward” multiple).

GD is appropriately valued when comparing its multiple to the 11.13x industry average. which supports the previous indication from the trailing EV/EBITDA.

Next Steps:

Basing your investment decision based on relative valuation metrics alone is certainly no sufficient. There are many important factors I have not taken into account in this article. If you have not done so already, I highly recommend you to complete your research by taking a look at the following:

1. Future Outlook: What are well-informed industry analysts predicting for ’s future growth? Take a look at our free research report of analyst consensus for ’s outlook.
2. Past Track Record: Has been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of 's historicals for more clarity.
3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

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Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article 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.