Last week I highlighted Raytheon (NYSE: RTN) as a stock that "has it all."

For the purposes of that article, "has it all" meant that the company has a business that I understand, a debt-to-equity ratio below 100%, and a return on unlevered net tangible equity above 20%, while its stock yields more than 2.5% and trades at a forward price-to-earnings ratio below 14.

But does this really all add up to a stock that promises significant returns? Let's find out.

Earnings expectations
As I outlined in a previous article, a good way to get a baseline for growth expectations is to check on what Wall Street analysts expect and how fast the company has actually grown in the past.

  Annual Growth Rate
Analysts' estimates 7.7%
10-year historical 28.0%
5-year historical 20.1%
3-year historical (5.9%)
Last 12 months (0.3%)

Source: Capital IQ, a Standard & Poor's company. Growth based on diluted earnings per share.

Now comes the tough part: How fast do we actually believe Raytheon can grow? While the company's historical growth looks pretty great, it's notable that part of that profit growth came as a result of the company de-levering itself. Ten years ago, Raytheon's debt-to-equity ratio was 94%, while it stands at around 37% today. Working off debt like that is a great thing, but it's also something we can't continue to count on to the same extent for future profit growth.

If we look at Raytheon's historical operating profit growth, it's a good deal lower -- 5.6% per year over the past 10 years and 10% over the past five. Profits have been crunched a bit over the past few years, and though I don't think we'll see huge defense spending cutbacks, I wouldn't count on rapid growth either.

Another consideration is the company's share count. Though Raytheon issued a bunch of shares early in the decade, it's been buying back shares more recently. Over the past five years, it's reduced its share count at a rate of nearly 4% per year. That can be good for shareholders' bottom line since a lower share count means a higher profit per share.

So what's a reasonable range of possible outcomes for Raytheon? I see analysts' estimates as pretty optimistic, so I've set the top end of my range at 7%. At the mid-point, I'm looking for 4% per year, and on the bottom end I assume that the company's bottom line stays flat.

Pinning down valuation
Valuations are a moving target that can be tough to predict, but, as with growth above, using a range of values can give us a view of our potential returns without requiring a Miss Cleo-type prescience.

In creating our range, a good place to start is where the stock is trading right now and what its historical trading range has been. In Raytheon's case, the stock has a current price-to-earnings ratio of roughly 10.4 times its trailing earnings. Over the past decade, it's had a very wide trading range with an average annual P/E as high as 116 in 2002 and as low as 10.4 seen recently

For broader context we can also look at how similar companies trade.



Trailing P/E

Estimated Growth

United Technologies (NYSE: UTX) Diversified industrial / defense 16.5 10.9%
Boeing (NYSE: BA) Transportation / defense 15.2 15.5%
General Dynamics (NYSE: GD) Defense 10.8 8.7%
Lockheed Martin (NYSE: LMT) Defense 10.9 7.6%
Northrop Grumman (NYSE: NOC) Defense 9.6 8.2%
L-3 Communications (NYSE: LLL) Defense 9.3 10%

Source: Capital IQ, a Standard & Poor's company.

Obviously these businesses aren't all exactly the same as Raytheon. The four companies that focus primarily on defense -- General Dynamics, Lockheed, Northrop, and L-3 -- are similar, but each contractor has its own particular mix of products and services. United Technologies and Boeing, meanwhile, have significant business in the private sector that gives them diversification from government customers. Both the companies' similarities and differences to Raytheon can give us some additional insight into how the market is valuing its stock.

Based on the group above, we can see that the market has more confidence in the two companies aren't totally reliant on defense spending. Meanwhile, Raytheon's multiple falls pretty much right in the middle of the other defense-focused companies.

So what can be expected of Raytheon's multiple in the future? My take is that the entire defense group has been unfairly beaten down and that multiples will rise in the years ahead, so the midpoint of my range is 14. On the upper-end, I could see investors paying 18 times earnings, while on the low-end I've assumed that it falls just slightly from the current multiple to 10.

Our final stop is to consider how much we'll get paid through dividends.

Raytheon's dividend history has been solidly OK. While the company hasn't cut its dividend over the past 20 years, the payout was stuck at $0.80 per share for a number of years as the company worked down its debt. As a result, the dividend growth over the past 10 years is just 6.5%. That rate has cranked up more recently though and over the past three years, the dividend has grown at a 14% annual rate.

Considering that the company's earnings may grow slowly, but it's been growing dividends significantly in recent years and has a low payout ratio, I think that dividend growth over the next five years could be as much as 15% or as low as 8% with a midpoint of 10%.

The verdict, please!
The end result of all of this is the returns we can expect under the various scenarios. Here's what my three scenarios would look like.


Annual EPS  Growth

Earnings Multiple

Annual Dividend Growth

Expected Annual Returns

Upside 7% 18 15% 22.7%
Mid-case 4% 14 10% 13.7%
Downside 0% 10 8% 3.1%

Source: Author's calculations.

Let's now go back to that question that we started with: Can Raytheon's stock double? Under the upside scenario, the answer is a very definite "yes." The more-likely mid-case scenario wouldn't offer a double over the next five years, but those expected returns are still pretty attractive for a quality company like Raytheon.

Of course the future is an ever-changing picture, so you need to keep on top of what's going on at Raytheon to see which set of numbers the company and stock are able to live up to. And you can do just that by adding Raytheon to your Foolish watchlist.

The Fool owns shares of General Dynamics, L-3 Communications, Lockheed Martin, Northrop Grumman, and Raytheon. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Fool contributor Matt Koppenheffer does not own shares of any of the companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or on his RSS feed. The Fool's disclosure policy prefers dividends over a sharp stick in the eye.