Investors in Science Applications International Corporation (NYSE:SAIC) had a bad week last week: Its stock plunged 8% in a single day after it reported earnings -- and ended the week even lower. SAIC shares are clawing back some losses this week -- but do they deserve to?

Let's find out.

A cartoon stock chart crashing through the floor

SAIC beat earnings last week, but then its stock crashed. Why was that? Image source: Getty Images.

What SAIC said in the report

SAIC's first fiscal quarter of 2018 actually didn't look that bad on the surface, with:

  • Sales rising 7% year over year to $1.2 billion
  • Operating profits up 5% at $66 million
  • Net income per share up a similar 5% to $1.13 per share

That being said, there were considerable caveats contained in SAIC's news, if you read between the lines. Take earnings, for instance.

Yes, per-share profits increased, but only because SAIC reduced its share count through buybacks. Actual net income for the company from continuing operations remained flat at $49 million. Profits also didn't grow as fast as sales, a consequence of profitability per dollar of revenue (operating margin) slipping 10 basis points to 5.6%, which offset some of the sales growth. Free cash flow for the quarter also declined, down 2% year over year to $82 million.

When all was said and done, SAIC ended up beating estimates for both sales and earnings. But its numbers were still something short of stellar.

What SAIC said after the report

Curiously, some of the most interesting information SAIC had to impart didn't actually make it into the company's published earnings report -- but was revealed only in the post-earnings conference call with analysts. It's here that SAIC revealed that its tax rate in Q1 was only 10% (which helped to boost earnings), whereas for the full year, taxes are expected to take a much more significant 20% to 22% bite out of earnings.

Here, too, SAIC reiterated its long-term hope to grow earnings at "low single digit" rates, and to expand its profit margins "10 to 20 basis points annually." Working off a 5.6% profit margin today, a 15-basis-point improvement in profits can only be expected to grow SAIC's earnings by about 3.6% per year. Added to low single digits growth in sales, this implies a long-term earnings growth rate of perhaps 8%.

What lies ahead

That's actually a little better than what Wall Street is forecasting. Analysts polled by S&P Global Market Intelligence, for example, are forecasting only a 5% long-term earnings growth rate for SAIC. Either way, whether the growth rate ends up being 5% or 8%, it's not a lot of growth to justify SAIC's price-to-earnings ratio of 20 -- even with a 1.5% dividend yield to sweeten the deal.

Furthermore, weaker profitability could be exacerbated if revenue gains slow down, as now appears likely given Q1's weak order bookings. SAIC noted that in its first fiscal quarter it scored a "book-to-bill" ratio of only 0.8, meaning that for every $1 in sales it made in the quarter, it replenished its sales pipeline with only $0.80 in new orders. It's entirely possible that the investors who sold off SAIC stock last week took that figure as a foreshadowing of slower sales.

I can't say that I blame them for doing that -- or for selling SAIC stock, either.

Rich Smith has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.