The S&P 500 officially entered correction territory on Wednesday as geopolitical concerns clashed with rising interest rates and inflation. Meanwhile, the Nasdaq Composite is down over 16% year to date and is just 119 basis points away from being down over 20% from its 52-week high -- which would officially mark the beginning of a bear market.
Investors looking for safe stocks to weather the story should look no further than defense contractor Lockheed Martin (LMT 0.48%). Despite being up nearly 10% year to date, the stock remains a great mix of value and income. Here's why it's a company worth owning now, especially for risk-averse investors who are more concerned with capital preservation than growth.
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A stable business
Lockheed's specialty is military aircraft like fighter planes and helicopters. But it also has a massive missile system segment. It also makes satellites, software systems that are vital staples of the U.S. defense industry, and several other products.
Over 75% of Lockheed Martin's business comes from the U.S. government and the rest from approved U.S. allies. This level of concentration from one buyer would normally be a red flag. But the U.S. government has deep pockets and is about as reliable of a customer as you could hope to ask for.
Since developing new products and services takes years, multi-year contracts add predictability to Lockheed's business. For example, it ended 2021 with a backlog of $135.4 billion, which is about two years' worth of sales.
Steady growth
Lockheed earned a record $67 billion in 2021 revenue, up just 2% year over year (YOY). It also earned $6.3 billion in 2021 net income, down around 8% from 2020. However, free cash flow (FCF) was $7.7 billion, up 20% YOY. Lockheed's 10-year chart points to steadily increasing sales, profit, and FCF.
LMT Revenue (Annual) data by YCharts.
Although Lockheed expects 2022 sales to fall a couple of percentage points to $66 billion and FCF to fall to $6 billion -- which is even lower than 2020 FCF -- it projects diluted earnings per share (EPS) to be $26.70, up 17% YOY and up 10% from 2020's record diluted EPS of $24.30.
In addition to flat-out higher net income, Lockheed's record forecast for diluted EPS is helped by massive stock repurchases, which were a record $4.1 billion in 2021. When a company buys back stock, it eliminates some of the outstanding shares, effectively increasing EPS. The $4.1 billion Lockheed spent buying back its stock (which was a great move in hindsight, considering the stock is up compared to 2021) is more than the $2.9 billion it spent on dividend payments (also a record high).
How Lockheed provides shareholder value
Simple math tells us that Lockheed used all of its 2021 FCF to buy back its stock and pay dividends. Growth-oriented investors would probably prefer Lockheed take some of that extra cash and reinvest it in the business. But for value and income investors, Lockheed's strategic decision to buy back a lot of stock and keep raising the dividend is music to their ears.
In Q4 2021, Lockheed raised its dividend to $2.80 per share per quarter -- marking the 19th consecutive year Lockheed has raised its annualized dividend. Even more than a high yield, consistent dividend raises are a trait that income investors look for when owning a dividend stock over a long-term time frame.
Lockheed is an inexpensive stock
Lockheed has stable earnings, predictable guidance, plenty of FCF to support its dividend, and is an industry-leading U.S. defense contractor. These characteristics make Lockheed well positioned in today's rising interest rate and inflationary environment.
On top of these advantages, Lockheed Martin is both an excellent value stock and a great dividend stock. It has a 2.9% dividend yield, which is much higher than the 1.4% average dividend yield in the S&P 500. Even better, Lockheed Martin is by no means an expensive stock. Based on its 2022 guidance of $26.70 in diluted EPS, Lockheed Martin stock has a forward price-to-earnings (P/E) ratio of just 14.6 compared to the 22.4 forward P/E of the S&P 500.
Not only does Lockheed have a safe and stable business that generates tons of cash, but it also has a much higher dividend yield and is much cheaper than most stocks in the S&P 500.
The step-change
For the last few years, Lockheed Martin stock has underperformed the S&P 500. This year, it is beating the S&P 500 by 20 percentage points and is on track to set a new all-time high.
In 2020 and 2021, the market was focused on growth. Growth companies saw their valuations balloon while low-growth companies tended to underperform. This year, it's the opposite. The market is forgiving low growth and is showing no patience for lack of profitability.
Investors would do well to be aware of these short-term market dynamics. Right now, all of Lockheed's strengths are coveted -- its dividend, value, predictability, and advantageous position in times of geopolitical tensions and war. Meanwhile, its lack of growth, which is still a long-term concern, is being forgiven.
Just as many growth-stock valuations got ahead of themselves last year, we could also potentially see share prices of Lockheed surge to unjustifiable levels. If that happens, investors need to be aware that the euphoria driving the stock higher, which again is this attitude of forgiveness toward low growth and a premium on profit, may not last.
As for the time being, Lockheed Martin looks like one of the best all-around dividend/value stock hybrids for investors that want to limit downside risk and generate passive income.
