Here we are at the three-quarters mark of 2014, and shares of Raytheon Company (RTN) have gained 13.5% in value. In a crazy world where a popular Chinese Internet IPO rises more than 30% in price on its first day of trading, that may not sound like much.
Then again, 13.5% is only a slightly larger gain than the average S&P 500 stock has enjoyed this year. In fact, if Raytheon stock were to keep on growing through the final quarter of this year, as it's grown in the first three quarters, the stock would end the year up 18%. Add a 2.6% dividend yield, and Raytheon stock's total return could exceed 20% -- roughly twice the average annual gain on the S&P 500.
But why?
RTN Total Return Price data by YCharts.
What Raytheon's doing right
There are actually three things that have kept Raytheon's shares trending higher so far this year. The first is that Raytheon is doing a lot of things right lately. This past summer, for example, Raytheon booked in excess of $1.7 billion worth of orders to supply rockets and missiles to the U.S. military and its allies over the course of just one month.
Rockets and missiles, of course, are Raytheon's bread and butter, accounting for about 28% of Raytheon's annual revenues, according to data from S&P Capital IQ. And these are high-margin revenues for Raytheon, too, producing operating profit margins of about 12.6%.
But Raytheon is more than just rockets. In recent months, we've seen Raytheon winning contracts to build everything from drones to high-tech howitzer rounds to higher-tech cannons to actual laser guns for the U.S. military. If things keep going this well for Raytheon, then Sequester or no Sequester, the company just might put to shame analyst projections of it growing earnings at 11% annually. That prospect alone has contributed to Raytheon's rise in stock price.
Where Raytheon's doing things right
Even more important to Raytheon as a company, and Raytheon as a stock as well, may be where the company is doing its growing. Because even if the U.S. Congress is cutting defense spending, the U.S. is hardly the whole of the global market for Raytheon's products.
Globally, Raytheon is top of the heap among pure-play defense contractors when it comes to winning orders outside U.S. borders. Approximately 25.5% of the company's business, in fact, comes from abroad. And as anyone who's opened up a newspaper lately knows, "abroad" -- Iraq, Syria, Japan, and so on -- is a hot market for military products these days. Raytheon's pole position in the international arms market is one of the factors that helps this stock stand out from the crowd in the defense industry.
Yet Raytheon's still priced wrong
Of course, the real key to why Raytheon's stock has "gone up" in recent months -- and the key reason it might well continue to rise in the future -- may be as simple as this fact: Relative to other U.S. defense contractors, Raytheon stock looks pretty cheap.
Priced at less than 16 times earnings, Raytheon shares sell for about a 21% discount to the valuation of most other members of the Aerospace/Defense Products & Services industry, where P/E ratios average closer to 19.5. This is despite the fact that, with overall operating profits margin of better than 13%, Raytheon does a better job of wringing profits from each revenue dollar than do most of its peers. (The average operating profit margin in this industry: 11%).
The upshot for investors
Now, this is not to say that Raytheon is an obvious bargain in its own right. Indeed, when you consider that companies on average tend to trade for about a 1x multiple to annual sales in this industry, you could argue that Raytheon, selling for 1.3 times sales today, may actually be overpriced. (PEG investors will also point out that paying 16 times earnings for Raytheon's 11% projected earnings growth rate is no great bargain).
But relative to the competition, Raytheon does look like kind of a great deal. So long as investors remain willing to pay through the nose for slower growing, higher priced defense contractors, there's little reason to fear they'll decide to do otherwise with Raytheon.
Raytheon stock has been blazing a trail like a Patriot missile. And it might still have some gas left in the tank. Source: Wikimedia Commons.
