Raytheon Company: Great Earnings Do Not a "Buy" Make

Profits growth and improved free cash flow don't change the fact that this stock is overpriced.

Feb 2, 2014 at 8:00PM

One of my very favorite defense contractors reported earnings this past week: Raytheon (NYSE:RTN). Its earnings "beat the Street." Investors cheered. But I'm still not buying the stock. And now I'll tell you why.

Reporting earnings for fiscal Q4 and full-year 2014 Thursday, Raytheon announced that:

  • Fiscal 2013 sales declined 3%, capped by a veritable collapse in Q4 sales -- down 9%, but operating profit margins actually gained about 20 basis points, rising to 12.4% for the year.
  • Net income climbed 6% as a result, and profits per diluted share grew 9% to $6.16, helped by a share-count reduction of 10 million.

So far, so good -- and it even gets better. Raytheon produced $2.4 billion in cash from operations in 2013, a 22% increase over 2012 operating cash flow. Combined with a modest reduction in cash outflows for capital investment, this translated into free cash flow of $2.1 billion, or a 30% improvement over 2012 FCF.

As a result, Raytheon's now generating about 5% more real, cash profit than it reports as net income under GAAP. Its true valuation is correspondingly cheaper. Rather than the 15.4 "P/E" ratio that you see as the stock's valuation on Yahoo! Finance, it may be better to think of the stock as selling for just 14.4 times free cash flow. Problem is -- that's still not cheap enough.

Valuation matters
With Raytheon trading at 14.4 times free cash flow today, you'd ordinarily want to see this stock growing its profits at about 12% annually to justify its stock price (taking into account Raytheon's 2.3% dividend yield). Heroic efforts to boost cash production, cut costs, and make up for a shrinking U.S. defense budget by selling more weapons systems abroad, however, were only sufficient to lift Raytheon up to 9% profit growth. (The free cash flow performance was better than that, but FCF is notoriously lumpy. Investors who are banking on seeing Raytheon continue to produce 30% cash profits growth year after year are bound to be disappointed.)

Given all this, it's hard to see how Raytheon achieves the 10.6% long-term growth in profits that Wall Street is expecting it to produce. And given that even if it does achieve 10.6% growth, the stock will still fall short of the level of growth necessary to justify its stock price, I can't recommend buying Raytheon stock at this point.

No matter how much I like it.

Raytheon is a good stock, but you deserve a better one
There's a huge difference between a good company (like Raytheon) and a good stock (not Raytheon), and a great stock that can actually make you rich. The Motley Fool's chief investment officer has selected his No. 1 stock for 2014, and it's one of those stocks that could make you rich. You can find out which stock it is in the special free report "The Motley Fool's Top Stock for 2014." Just click here to access the report and find out the name of this under-the-radar company.

Rich Smith has no position in any stocks mentioned. The Motley Fool owns shares of Raytheon. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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