How much should defense stocks cost? In 2017, I dived deep into this issue, concluding that on average and over a long span of time (17 years), U.S. defense stocks had historically sold for a valuation of almost exactly 1 times sales.
I don't know about you, but 17 years seemed like a pretty hefty data set to me. Big enough, in fact, that when I saw most large defense stocks selling for closer to 1.6, 1.7, or even 1.8 times trailing sales in 2017, that meant these stocks cost too much. And so I advised investors to avoid defense stocks in 2017.
Was I right about that or wrong?
Well, it depends on the stock.
Image source: Getty Images.
Boeing versus everyone else
In February 2017, when I wrote that article, Boeing (BA +1.96%) shares cost about $177. Boeing stock costs closer to $150 today, so score one for me. But what about the rest of the defense industry?
NYSE: BA
Key Data Points
In the chart below, I show how 10 of the best-known defense stocks performed over the past seven years. Take a look ... and then I'll tell you how they stack up against the S&P 500's performance over the same timespan:
|
Percentage Change February 2017 to October 2024 | |
|---|---|
|
Boeing |
-15% |
|
Huntington Ingalls (HII +2.78%) |
+18% |
|
General Dynamics (GD +0.66%) |
+58% |
|
RTX Corp (RTX +1.12%) |
+75% |
|
Textron (TXT +0.56%) |
+85% |
|
L3Harris (LHX +0.77%) |
+118% |
|
Northrop Grumman (NOC 0.95%) |
+120% |
|
Lockheed Martin (LMT +2.43%) |
+127% |
|
Kratos Defense (KTOS +10.07%) |
+191% |
|
Leidos (LDOS +0.41%) |
+205% |
Data source: Yahoo! Finance.
Pretty impressive, huh? Four doubles and a triple in that list, and nine winners versus just one loser. And yet, over the same time, the average S&P 500 stock rose 143%.
That's right. All but two of the defense stocks named above underperformed the S&P. And this is with two major active military conflicts in different parts of the globe, and an ongoing arms race in the South China Sea, boosting the visibility of defense stocks. Despite all these tailwinds, most defense stocks still underperformed the S&P.
It kind of seems like I was right to call defense stocks overpriced back then. And here's the thing that should really worry you:
They're overpriced again today.
Check your assumptions
Can I prove this? Sure. Start by assuming (despite the evidence above) that I was wrong in 2017. Assume the "natural" valuation of a defense stock is not 1 times sales, but something higher.
To test this theory, I revisited my valuations of these 10 popular defense stocks, checking their price-to-sales ratios over the last 10 years (and the 10 years before that) and also their valuations over the last 20 years combined.
Here's how the numbers break down:
|
Average Enterprise Value-to-Sales Ratio (EV/S) From: | |||
|---|---|---|---|
|
2004-2013 |
2014-2023 |
2003-2023 | |
|
Boeing |
0.9 |
1.8 |
1.4 |
|
General Dynamics |
1.0 |
1.7 |
1.4 |
|
Huntington Ingalls |
0.5* |
1.1 |
0.6* |
|
Kratos Defense & Security Solutions |
1.0 |
2.2 |
1.6 |
|
Leidos Holdings |
1.5** |
2.2 |
1.3** |
|
L3Harris Technologies |
1.4 |
2.8 |
2.1 |
|
Lockheed Martin |
0.8 |
1.8 |
1.3 |
|
Northrop Grumman |
0.7 |
1.9 |
1.3 |
|
RTX Corporation |
1.4 |
2.1 |
1.7 |
|
Textron |
1.3 |
1.2 |
1.2 |
|
Average |
1.1 |
1.9 |
1.4 |
Data source: S&P Global Market Intelligence. *Huntington Ingalls data begins in 2011, the year when Northrop Grumman spun off Huntington Ingalls as a separate company. **Leidos data begins in 2006, the year of its IPO. Data on its average enterprise value-to-sales ratio for 2014 is missing because the company changed its fiscal year in 2015, skewing the data somewhat.
I next ran the numbers to compare these stocks' valuations today, both as enterprise value-to-sales (EV/S) and by the more common price-to-sales (P/S) metric (simply because the latter data is a bit easier for most investors to find and confirm).
|
EV/S Today |
P/S Ratio Today | |
|---|---|---|
|
Boeing |
1.9 |
1.3 |
|
General Dynamics |
2.0 |
1.8 |
|
Huntington Ingalls |
1.1 |
0.8 |
|
Kratos Defense & Security Solutions |
3.4 |
3.3 |
|
Leidos Holdings |
1.7 |
1.4 |
|
L3Harris Technologies |
2.8 |
2.2 |
|
Lockheed Martin |
2.3 |
2.0 |
|
Northrop Grumman |
2.3 |
1.9 |
|
RTX Corporation |
2.8 |
2.3 |
|
Textron |
1.3 |
1.2 |
|
Average |
2.2 |
1.8 |
Data sources: S&P Global and Finviz.com.
What this means for defense stock investors
From the data above, one could argue that a more dangerous world means military stocks are worth more today than they were in the past. Even if defense stocks were worth only 1 times sales in the past, the "new" fair valuation for defense stocks, over an even longer period of time, might be 1.4 times sales.
Well and good.
But even if that is the case, literally every single defense stock on this list currently costs more than its average 20-year valuation. As a defense writer, I'd obviously prefer if the data showed something different so that I could recommend buying a few more defense stocks -- but it simply doesn't.
Defense stocks still cost too much, and investors who buy them today will almost certainly underperform a plain vanilla index fund over the next several years.
