Has Northrop Grumman Become the Perfect Stock?

Every investor would love to stumble upon the perfect stock. But will you ever really find a stock that provides everything you could possibly want?

One thing's for sure: You'll never discover truly great investments unless you actively look for them. Let's discuss the ideal qualities of a perfect stock, then decide if Northrop Grumman (NYSE: NOC  ) fits the bill.

The quest for perfection
Stocks that look great based on one factor may prove horrible elsewhere, making due diligence a crucial part of your investing research. The best stocks excel in many different areas, including these important factors:

  • Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.
  • Margins. Higher sales mean nothing if a company can't produce profits from them. Strong margins ensure that company can turn revenue into profit.
  • Balance sheet. At debt-laden companies, banks and bondholders compete with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
  • Money-making opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.
  • Valuation. You can't afford to pay too much for even the best companies. By using normalized figures, you can see how a stock's simple earnings multiple fits into a longer-term context.
  • Dividends. For tangible proof of profits, a check to shareholders every three months can't be beat. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.

With those factors in mind, let's take a closer look at Northrop Grumman.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-year annual revenue growth > 15%

(3.6%)

Fail

 

1-year revenue growth > 12%

(4.5%)

Fail

Margins

Gross margin > 35%

22.1%

Fail

 

Net margin > 15%

7.8%

Fail

Balance sheet

Debt to equity < 50%

41.4%

Pass

 

Current ratio > 1.3

1.39

Pass

Opportunities

Return on equity > 15%

19.9%

Pass

Valuation

Normalized P/E < 20

9.36

Pass

Dividends

Current yield > 2%

3.2%

Pass

 

5-year dividend growth > 10%

7.8%

Fail

       
 

Total score

 

5 out of 10

Source: S&P Capital IQ. Total score = number of passes.

Since we looked at Northrop Grumman last year, the company has kept its five-point score for the third year in a row. The stock has done reasonably well, rising more than 10% over the past year.

The defense industry has been under siege for years from the threat of budget cuts, and finally, some of those threats have become reality. With sequestration having taken effect, spending cuts across the Defense Department have had an impact on projects large and small.

But rising tensions with North Korea have given Northrop and many of its peers the prospect of increased business with the Pentagon. Now that North Korea has said that it has a long-range missile that could reach the West Coast, the U.S. says it plans to increase funding for Lockheed Martin's (NYSE: LMT  ) Aegis missile-defense system, and Boeing (NYSE: BA  ) and Raytheon (NYSE: RTN  ) have defensive anti-missile weapons that will see increased sales as well. Northrop is the prime contractor for the Joint National Integration Center for the Missile Defense Agency, and it too should see increased expenditures if North Korea's posturing continues.

Still, Northrop hasn't been immune from the prospects of a shrinking overall defense-spending pie. Both Northrop and Lockheed have been cutting back on their respective workforces already, and if sequestration lasts much longer, they'll probably have to make additional cuts.

For Northrop to improve, it needs to look beyond the U.S. to find other countries that are willing to spend more on defense. Just as international markets have helped other industries, Northrop should be able to boost its profits if it can tap into growing countries with a need to defend their borders from outside threats.

Keep searching
No stock is a sure thing, but some stocks are a lot closer to perfect than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate out the best investments from the rest.

Unlike Northrop and other defense contractors, Boeing has a massive opportunity in civilian aerospace. But will Boeing live up to its shareholder responsibilities and get its big order backlog delivered to its customers? In our premium research report on the company, two of The Motley Fool's best minds on industrials have collaborated to provide investors with the key, must-know issues surrounding Boeing. They'll be updating the report as key news hits, so don't miss out — simply click here now to claim your copy today.

Click here to add Northrop Grumman to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.


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