Both Huntington Ingalls Industries (NYSE:HII) and General Dynamics (NYSE:GD) are key suppliers to the U.S. military and its allies. With the U.S. President and the GOP talking about increasing military spending, providing the machines of war seems like a decent industry focus. But are either of these two companies worth buying? Here's a look at some of their key valuation metrics to help us answer that question.
A defensive look at things
My first move is always to take the approach of Benjamin Graham's defensive investor, as outlined in his investing classic The Intelligent Investor. A defensive investor is looking for a large company with a good earnings and dividend track record. Huntington Ingalls, which is largely focused on making ships for the U.S. armed services, traces its history back to the late 1800s. However, it has only been a public company since 2011, when it was spun off from Northrop Grumman.
That means it doesn't yet have 10 years of history as a stand-alone entity. Of course you could go back and look at the segment's performance within Northrup, but that isn't a clean picture. You would have to make a lot of estimates for things like the shared costs of accounting versus the cost Huntington would have to pay if it were on its own.
With a $10 billion market cap, the shipbuilder is certainly large enough for defensive investors, but a true defensive investor should probably avoid it for another few years. Looking past the short history, the company's dividend has gone up annually since being initiated in 2012. Earnings, meanwhile, have also grown consistently and materially since 2012. (It lost money in 2011, but that was the year it was spun off and the red ink shouldn't be held against it because of the big corporate change.)
General Dynamics, which is a more widely diversified aerospace and defense company, is the larger entity here with a $60 billion market cap. Its dividend has been heading generally higher over the last decade. Earnings hit a snag in 2011 because of a $2 billion impairment charge in the information systems and technology division, but it has otherwise been consistently profitable. Earnings in 2016 were nearly double what they were a decade ago. General Dynamics easily passes the defensive investor test.
What about the price?
That, however, is just the first screen, because there's a difference between a good company and a good investment. Benjamin Graham would likely argue that valuation is the key determinant of the latter. And on that score, neither Huntington Ingalls nor General Dynamics is particularly appealing today. Here's what some key valuation metrics show us.
General Dynamics' price-to-earnings ratio is around 19 today, higher than its five-year average of just about 15. That's lower than the S&P 500's composite average P/E of 22, but it still doesn't look cheap when you compare the P/E to the company's own history. Huntington Ingalls' P/E of 17.7 is close to its five-year average of 17, which makes it more reasonably priced, but not cheap relative to its own history. Neither one looks particularly compelling on this metric.
Price-to-book value ratio is no different. General Dynamics' P/B ratio is roughly 5.2 compared to a five-year average of 3. Huntington Ingalls' P/B is 6.2 compared to the longer-term average of 3.6. The S&P 500's average P/B is around 3, which means neither of these two military contractors look like a deal today.
The price-to-sales ratio continues the trend. General Dynamics' P/S ratio is around 2 currently, but its five-year average is 1.2. Huntington Ingalls' P/S ratio is roughly 1.5, more than double its five-year average of 0.7. The S&P 500's average P/S ratio is around 2.2, so both appear cheaper than the market on this metric, but not cheap relative to their own histories.
There's a little bit of a divergence on the dividend front. Huntington Ingalls' dividend yield is around 1.2% today versus a five-year average of 0.8%. That suggests an opportunity, but with a short history and other valuation metrics suggesting overvaluation, I would err on the side of caution here. Moreover, the dividend is still relatively new, which suggests the average is biased lower by relatively low early yields as the dividend was raised over time. General Dynamics' dividend yield is 1.7%, below its historical average of 2.1%, continuing the trend of metrics that suggest it is expensive today.
No bargains here
I'm confident that both General Dynamics and Huntington Ingalls are good companies. But the numbers suggest they aren't particularly compelling values today. Of the two, Huntington Ingalls is probably the cheaper option, but its short history as a public company and the relatively high P/S and P/B ratios should be enough to push conservative investors to the sidelines. General Dynamics, meanwhile, appears relatively expensive on every metric we looked at. At this point, I don't think either of these two companies is the better buy.