What are we looking for?
U.S. President Donald Trump's first budget is expected to be released mid-March, and if he delivers what he promised many times, it should include a significant increase in defence spending. Since the Nov. 8, 2016, presidential election, the S&P Aerospace & Defence Index has gained about 17 per cent, but there could be more to come. This week, we are comparing 17 aerospace & defence stocks of our universe to see how they rank based on some economic performance and valuation criteria.
The screen
We have ranked the 17 stocks with the following criteria:
- The economic performance index, or EPI (return on capital divided by cost of capital). An EPI ratio of 1.0 or more indicates a company’s capacity to create wealth for its shareholders (a higher EPI displays a greater rate of wealth creation);
- The return on capital;
- The return on capital change over the past 12 months;
- The future growth value. The FGV represents, in percentage, the portion of the total market value that exceeds the company’s current operating value. The higher the number, the higher the baked-in premium for expected growth is, and the higher the risk. A negative number reflects a discount;
- The free-cash-flow to capital ratio. This ratio gives a sense of how well the company uses the invested capital to generate free cash flows, which could be used to stimulate growth, pay and/or increase dividends, reduce debt, etc. A positive figure is good – 5 per cent and above is excellent;
- The dividend yield (can include special dividends);
- The one-year and four-year annualized dividend growth rates.
More about StockPointer
StockPointer is a fundamental analysis tool based on an EVA (economic value added) model to quickly and easily identify investment opportunities. In addition to providing detailed reports on more than 7,500 companies (Canadian stocks, U.S. stocks and American depositary receipts), StockPointer also allows investors to create personalized filters and build custom portfolios.
What did we find?
First, we can state that this industry is currently not cheap. All 17 stocks are trading at premiums for expected future growth, which shows how optimistic the valuations already are. Nonetheless, some companies still appear interesting thanks to their robust economic performance and high dividend growth rates. Boeing Co. and Lockheed Martin Corp. come up as the highest ranked stocks based on the EPI. Interestingly, their FGV premiums are not as high as most of the stocks in that group even though they offer among the highest dividend yields, dividend growth rates and free cash flows.
Northrop Grumman Corp. and Raytheon Co. also offer a good balance of economic performance, reasonable valuation with FGV premiums around 30 per cent, aggressive dividend growth rates and high free cash flows. The other companies are not necessarily bad, but their higher premiums and lower economic performance give the impression of "paying more for less."
Investors are advised to do additional research prior to investing in any of the companies mentioned.
Jean-Didier Lapointe is a financial analyst for StockPointer at Inovestor Inc.