Lockheed Martin's F-35 Joint Strike Fighter. Photo: Wikimedia Commons.

On a "green" day for stock markets generally, Lockheed Martin's (LMT 1.71%) stock is up more than 2% after the defense contractor reported second-quarter results that broadly exceeded expectations.

For the quarter, Lockheed Martin reported:

  • Revenue declined 1% to $11.3 billion, with sales falling pretty much across the board. The only Lockheed unit to post a marked increase in sales was its aeronautics business -- i.e., the F-35 Joint Strike Fighter. (Fortunately, $11.3 billion was still more than the $11.14 billion that Wall Street was looking for. Result: a "sales beat.")
  • Earnings per diluted share climbed 5% year over year to $2.76. Again, this topped expectations (for $2.66 per share), with the result being that investors see it as good news.
  • Cash generated from operations shot up 57% from last year's second quarter, hitting $977 million.
  • This brings the company to $3.1 billion in operating cash flow generated year to date -- a 14% increase year over year. With capital expenditures declining, the company's increase in free cash flow is even bigger -- more than 16%, at $2.8 billion generated over the course of the year's first half.

So the good news is that sales and earnings, while not exactly setting the world on fire growth-wise, at least exceeded expectations. And the better news is that this trend in Lockheed Martin stock should continue.

The expectations game
Lockheed predicted that over the course of 2014 it will earn anywhere from $10.85 to $11.15 per share. Management is convinced that its earlier estimates for earnings, which topped out at $10.80 per share, were too low. It's now basically guaranteeing that the least the company will earn this year is more than the most it expected to earn just three short months ago.

Considering that expectations for revenue ($44 billion-$45.5 billion) and new orders ($41.5 billion-$43 billion) have not changed at all, this means Lockheed Martin is doing a better job of converting revenue into profit.

But is it a buy?
Ah, that's the question. While the company is more profitable than management thought it was just three months ago, Lockheed Martin shares also cost about 7% more than they did on April 22, 2014. And this could pose investors a problem.

Consider: At $166 and change, a share of Lockheed Martin stock costs a bit more than 16.3 times earnings. Analysts expect the company to continue growing earnings over the next five years, but at only roughly 9%. This gives the company a "PEG" ratio (the P/E ratio divided by the growth rate, as a whole number) of about 1.8, which seems pricey when you consider that the average stock in the defense industry is selling for closer to a 1.4 PEG ratio.

And yet, if you ask me, Lockheed Martin may be worth the premium price.

Despite reporting "only" $3.2 billion in trailing generally accepted accounting principles net profit, Lockheed Martin has generated a whopping $4.1 billion in real cash profit -- free cash flow -- over the past 12 months. Divided into the company's market capitalization, this results in a price-to-free cash flow ratio of only 12.8 on the stock. Meanwhile, the stock's 8.9% growth rate and 3.2% dividend yield mean that Lockheed Martin investors are getting a "total return" of about 12.1% on the shares.

Long story short, it's not the cheapest defense stock out there. But Lockheed Martin stock does still look reasonably priced, even after today's run-up.