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Better Buy: Raytheon (RTN) vs. General Dynamics (GD)

By Dan Caplinger - Dec 29, 2017 at 8:59AM

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Which defense contractor is the smarter choice?

The defense industry has been rising during 2017, and political moves like the White House's support of higher military spending has made investors enthusiastic about shares of defense contractors like Raytheon (RTN) and General Dynamics (GD 2.35%). In particular, these giants have been key players in some of the most important military hardware systems currently used by the U.S. Armed Forces, as well as military agencies across the globe.

For those who are bullish on defense, deciding whether Raytheon or General Dynamics is more likely to outperform the other takes some careful thought. Below, we'll compare Raytheon and General Dynamics using some common benchmarks to see which seems like the right pick.

Missile launching from a truck-based platform in a desert battlefield on a cloudy day.

Image source: Raytheon.

Valuation and stock performance

Defense contractors across the sector have had good performance over the past year, but between these two companies, Raytheon has been the better choice. Its stock has climbed 32% since December 2016 compared to a 17% rise for General Dynamics over the same period.

Raytheon's outpaced gains have extended its valuation using some basic earnings-based methods. General Dynamics has a trailing earnings multiple of just 19 compared to Raytheon's figure of 26 times trailing earnings. When you incorporate future earnings projections into the mix, Raytheon gets a bit less expensive, but its forward multiple of 23 still is well ahead of General Dynamics' multiple of 19. For value investors, General Dynamics looks like the better bet, even though its stock hasn't done as well as Raytheon's lately.

Dividends

Both Raytheon and General Dynamics have very similar dividend profiles right now. Both companies have yields of about 1.7%, as dramatic gains in their stock prices have depressed what had previously been more generous dividend yields.

In terms of consistent dividend growth, General Dynamics looks a bit more favorable. The contractor has boosted its dividends each year for 26 straight years, achieving the status of Dividend Aristocrat back in 2016. Its most recent dividend increase amounted to 11%, making its quarterly payment $0.84 per share. Raytheon has only made dividend increases for half as long, but 13 years of growth culminating in a 9% rise earlier this year, to $0.7975 per share, still leaves the contractor holding its own. Both companies pay out about 30% of their earnings as dividends.

On the dividend front, Raytheon and General Dynamics finish in a virtual dead heat. Only General Dynamics' place on the Dividend Aristocrat list gives it the tiniest of edges.

Growth prospects and risk

Defense contractors share plenty of common risks, with many factors affecting companies throughout the industry equally. But that doesn't mean that Raytheon and General Dynamics have identical growth prospects.

Raytheon has had an extremely strong year. The company's focus on missiles and missile defense systems, along with communications and security, has been of particular interest to the Defense Department in the U.S., and Raytheon's efforts to fight cyberattacks has been a smart diversifying move. Patriot-missile systems are well-liked across the globe, with many U.S. allies using the system, and Raytheon has done a good job of promoting sales to new customers.

The successful business performance for the company prompted Raytheon's board of directors late in the year to authorize up to $2 billion in stock repurchases, adding further fuel to share-price gains. The one shortcoming is that Raytheon doesn't really have exposure to the thriving commercial aerospace arena, which has been a growth driver of the civilian economy for years.

By contrast, General Dynamics hasn't been able to keep up the pace during 2017. The contractor's emphasis on naval vessels, tanks, and armored vehicles haven't been among the top-priority items for Defense Department procurement specialists, and rivals have been well-positioned to capitalize on any new business that comes in those areas. Moreover, although General Dynamics has exposure to the civilian aircraft manufacturing industry, its Gulfstream business jet division has suffered from sluggish demand.

Gains in the commercial sector have come largely from sales of larger airliners, and a general perception that business jets reflect corporate excess has weighed on General Dynamics' growth from that segment. Some are hopeful that business jet demand will rise, in which case 2018 could be more favorable, but for now, General Dynamics faces some challenges.

Overall, neither Raytheon nor General Dynamics is the perfect pick right now. Those who favor rebound stories might prefer General Dynamics and its cheaper valuation, while others who like positive momentum will stick with the more expensive Raytheon. If defense spending picks up across the board, then both stocks could fare well in the years to come.

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Stocks Mentioned

General Dynamics Corporation Stock Quote
General Dynamics Corporation
GD
$219.56 (2.35%) $5.03
Raytheon Company Stock Quote
Raytheon Company
RTN

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