General Dynamics Corporation (NYSE:GD) and Raytheon Company (NYSE:RTN) are two of the largest U.S. military contractors. They provide the government everything from missiles to data services. They are both well-run and well-respected companies. But is either of these names a good value today?
To answer that question, we're going to step back and look at them the way Benjamin Graham -- the man who helped mold Warren Buffett -- might have.
The defensive view
One of the first things that Graham writes about in his influential book, The Intelligent Investor, is the difference between a defensive investor and an enterprising investor. Most investors should err on the side of being defensive to help keep risk to a minimum. That means sticking to large companies with long and successful operating histories and notable dividend records.
General Dynamics has a roughly $60 billion market cap. It has posted a profit in nine of the last 10 years, with earnings per share expanding by around 90% over that span. It has increased its dividend for 26 consecutive years. Raytheon has a $54 billion market cap. It has posted positive earnings in 10 of the last 10 years, with earnings growing roughly 30% over the period. It has increased its dividend for 13 consecutive years.
General Dynamics stacks up a little bit better here, but I believe both would easily qualify as a defensive stock for Graham. Which means it's time to compare the price Mr. Market is offering for these two companies.
What's it worth?
One of the key tenets of Graham's approach is the distinction between a company as a business and the price you pay for it in the stock market. Even the best company in the world can be a horrible investment if you pay too much for it. A quick look at some key valuation ratios tells an important story here.
For example, General Dynamics' price-to-earnings ratio is around 19 today, while Raytheon's P/E is around 25. Clearly General Dynamics is the cheaper option. But don't stop there. General Dynamics' P/E is nearly 30% higher than its five-year average P/E. That's better than the 75% difference at Raytheon, but a higher than average P/E doesn't suggest a bargain price.
Looking at price-to-book value shifts the comparison a little bit. Both General Dynamics and Raytheon have P/B ratios of around 5. However, the five-year average for both is roughly 3. Although they both look to be offering a similar valuation here, neither of these two military industrial firms look particularly compelling on this metric, either.
General Dynamics' price-to-sales ratio, meanwhile, is roughly 2, compared to a P/S ratio of 2.2 for Raytheon. That makes General Dynamics look like the less expensive option again. But the five-year average P/S ratio for each is 1.2. So, as with the other two metrics we've looked at, neither of these two companies appear to be a steal at these price levels.
Moving on to their price-to-cash-flow ratios, we see the same general trend. Raytheon's PC ratio of 24.2 is higher than General Dynamics' 22.6. But General Dynamics' PC ratio is 35% above its five-year average. Raytheon's is around 60% above its average. Once again, neither of these stocks look like a compelling value, though General Dynamics appears to be the cheaper option.
Too expensive today
When you compare General Dynamics and Raytheon, General Dynamics comes out looking like the better value. But that's only relative to Raytheon. If you examine these military industrial contractors relative to their own histories, they both look expensive right now. In the end, I'd pass on both and wait for more compelling valuations.