What are we looking for?
Due to the rising tensions in Eastern Europe and elsewhere around the globe, my colleague Rob Belanger and I decided to look at the defence sector.
We started with worldwide companies greater than $1-billion (U.S.) in market capitalization and sorted them from the largest to the smallest.
The enterprise value divided by earnings before interest, taxes, depreciation and amortization (EV/EBITDA) is one of the most commonly used valuation metrics. We are looking for a low number.
The enterprise value compared with sales is a valuation measure that shows how much it costs to buy the company’s sales. The lower the EV/sales the more attractive, or undervalued, is the investment.
The free cash flow (FCF) yield is an evaluation of a company showing the free cash flow per share that a company is expected to earn compared to its market price per share. Investors want to pay as little as possible for as much earnings as possible, so a lower ratio means the investment is less attractive.
Operating margin is a measurement of what proportion of a company’s revenue is left over after paying for variable costs of production, such as wages, promotion, etc. A healthy operating margin is required for a company to be able to pay for its fixed costs, such as interest on debt, and the higher the better.
The inventory to total assets is an efficiency ratio that looks at the portion of assets that are tied up in inventory. Generally, a lower number is better.
What did we find?
BAE Systems PLC is a British company that designs and produces naval guns, missile launchers, armoured vehicles, submarines and fighter aircraft. The company has the most attractive EV/EBITDA in our screen.
Rheinmetall AG is a German firm that manufactures helicopters, systems for battle tanks and other products; it leads in the EV/sales metric.
Raytheon Co. makes torpedoes, missiles and airborne decoys; the company has the best FCF yield.
Rounding out our screen is Northrop Grumman Corp. and GenCorp. Inc.; they lead in the operating margin and inventory to total assets categories, respectively.
Be sure to do your own research or contact an investment professional before buying any of the companies listed here.