When Fool analyst Anand Chokkavelu checked his watchlist and saw an entire industry sliding consistently and dramatically downward, he had to take a look. What he found led him to purchase not one, but five of the key players in the industry.
"There's a lot of gloom and doom surrounding defense and aerospace, and investors have been racing to sell their shares," says Anand. "But the reaction has been far greater than the expected budget cuts deserve. Yes, there might be a smaller pie as a result of Department of Defense cuts, but there's still going to be a pie."
Digging in, Anand was able to sort through his watchlist and find that many of the major players sport historically low multiples. "Any time you can find a company selling at 10 times earnings, you have to take a look. That implies no growth. The defense industry is offering us several blue chips trading for earnings multiples around 10. That's just silly." Incidentally, he was also intrigued by Boeing (NYSE: BA) as an outstanding stalwart, but ultimately decided it wasn't cheap enough. "It's a great company, but I'm looking for rock bottom."
|
Company |
P/E Ratio (2001) |
P/E Ratio (2006) |
P/E Ratio (Recent) |
|---|---|---|---|
| General Dynamics (NYSE: GD) |
16.6 |
17.6 |
10.8 |
| Lockheed Martin (NYSE: LMT) |
28.9 |
17.0 |
9.8 |
| Northrop Grumman (NYSE: NOC) |
12.3 |
17.1 |
9.8 |
| Raytheon (NYSE: RTN) |
38.3 |
19.9 |
10.1 |
| L-3 Communications (NYSE: LLL) |
33.5 |
19.1 |
9.1 |
Source: Capital IQ, a division of Standard & Poor's. The P/E ratios for 2001 and 2006 are averages for the years. The recent P/E ratio is as of the Jan. 4 close.
Anand then looked at each company's return on capital to make sure they haven't lost their earnings efficiency and found that four of the five enjoyed upward trends from 2001 to 2006 to today (General Dynamics dropped from 2001 to 2006, but rebounded from there). So he bought shares of all five for his Rising Stars real-money portfolio.
Why not pick just one? He can't read the tea leaves and determine which company is going to receive which defense contract. But he feels pretty confident that in the budget give and take, one of the companies in his basket of defense contractors will come out on top in the majority of the deals. Still, despite the beaten-down nature of the industry, Anand has moderated his expectations. "I'm not looking for shares to skyrocket -- just hoping to take advantage of a bit of overdone market pessimism. There's an additional opportunity to beat the basket returns by diving in deeply and analyzing each company on its own particular merits. I may do so in the future, but for today, I'm happy with a higher-level basket approach."
Still not cheap enough? Or perhaps you want to investigate further to pick one winner. Regardless, it's smart to watch to get a feel for a company and decide if you want to own it. Click below to start watching on the free MyWatchlist service from the Fool.
