President-elect Trump ran on a promise to "make America great again." In one respect, his election on Tuesday is already turning out to be great news for investors in defense stocks.
This morning, analysts at Barclays Capital reacted to news of the Trump win with a series of new upgrades for defense stocks. Lockheed Martin (LMT 0.16%), L-3 Communications (LLL), Northrop Grumman (NOC -0.38%) -- tic-tac-toe, three-in-a-row, Barclays upgraded each and every one.
But which of these defense stocks does Barclays like best? And in light of their widely varying valuations, which of these stocks should you like best for your portfolio? (And is there an even better option that Barclays might be missing?) That's what we're here to find out.
From least to greatest: Lockheed Martin
Let's start with the stock Barclays likes least: Lockheed Martin. The nation's biggest pure-play defense contractor by revenue, S&P Global Market Intelligence reports that Lockheed Martin did $50.6 billion in business over the last 12 months, and earned $5.2 billion in profits on that business. That works out to a very respectable 10.4% net profit margin, and makes Lockheed Martin nearly twice as profitable (per revenue dollar) as it was five years ago.
Lockheed Martin stock seems inexpensive at just 14.1 times earnings. With a growth rate currently estimated at just 8.2% annualized over the next five years, it's not the best bargain on the market, and Barclays rates the stock only equal weight. Even so, in light of the Trump victory, the analyst has upgraded the stock from its old rating of underweight, and added $30 to its price target -- to $275 a share.
A "100% likelihood" to benefit? L-3 Communications
What leads Barclays to think Lockheed, and these other stocks as well, will benefit? As explained in a write-up on TheFly.com today, Barclays believes "the market will assign a 100% likelihood of higher near-term defense spending under a Trump administration."
This belief is enough to convince the analyst to upgrade L-3 Communications as well, and this time it's going all the way to an overweight rating, with a price target set at $165. Curiously, though, while L-3 gets a higher rating from Barclays, most analysts see its growth prospects as slightly inferior to Lockheed's. Consensus estimates call for only 7.9% growth at L-3 over the next five years, and with L-3 shares already trading for more than 32 times trailing earnings, that would appear to make L-3 stock a riskier bet.
Top o' the heap: Northrop Grumman?
Perhaps the single stock Barclays likes best is Northrop Grumman -- but it's hard to imagine why. At 20 times trailing earnings, Northrop is not the most expensive stock in the defense space, but neither is it the cheapest. Northrop's 1.5% dividend yield is less than the 1.9% that L-3 pays, and barely half of Lockheed Martin's beefy 2.9% payout.
In fact, the one thing that Northrop does seem to have going in its favor is the fact that analysts were expecting it to outgrow its rivals. Consensus estimates were calling for 9.2% long-term earnings growth at Northrop Grumman -- and that was before Trump won the election.
Is there a better way to profit from a Trump presidency?
Barclays rates Northrop Grumman stock overweight,q just as it does L-3 Communications. Moreover, the $270 price target it assigns to Northrop Grumman stock implies similar upside for both stocks -- about 11% from current prices. But if you ask me, there's an even bigger opportunity in defense stocks than any of the three Barclays names: Boeing (BA 2.13%).
With a smaller defense business than Lockheed's, Boeing's large commercial aircraft arm makes it a bigger company overall. In fact, at $94.8 billion in annual sales, Boeing is nearly twice the size of Lockheed by revenues (and pays an even bigger dividend -- 3%).
Valued on GAAP earnings, Boeing stock looks similar to Northrop's, with a P/E ratio of 20.9. But Boeing has such strong cash production that, at last report, the stock was selling for less than 11 times annual free cash flow. At the same time, its 15.5% projected profits growth rate dwarfs those of the aerospace and defense rivals that Barclays endorsed today -- and gives Boeing stock a PEG ratio that looks downright cheap at just 0.7.
All things considered, while I don't disagree with Barclays' major thesis that defense stocks will benefit from a Trump presidency, I fear the analyst may be overlooking the best stock of the bunch: Boeing.