Is Harris Destined for Greatness?

Investors love stocks that consistently beat the Street without getting ahead of their fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with robust and improving financial metrics that support strong price growth. Does Harris (LHX 0.01%) fit the bill? Let's look at what its recent results tell us about its potential for future gains.

What we're looking for
The graphs you're about to see tell Harris' story, and we'll be grading the quality of that story in several ways:

• Growth: Are profits, margins, and free cash flow all increasing?
• Valuation: Is share price growing in line with earnings per share?
• Opportunities: Is return on equity increasing while debt to equity declines?
• Dividends: Are dividends consistently growing in a sustainable way?

What the numbers tell you
Now, let's look at Harris' key statistics:

HRS Total Return Price data by YCharts,

Source: YCharts.
*Period begins at end of Q2 2010.

HRS Return on Equity data by YCharts

Source: YCharts.
*Period begins at end of Q2 2010.

How we got here and where we're going
We first looked at Harris last year, and it has lost two passing grades in its second assessment, earning only three out of nine possible passes this time. Over the past few quarters, Harris' profits margins have imploded, because of telecom companies that are tightening up on their capital expenditures and the U.S. government sequester. Despite this apparent weakness, Harris shareholders have enjoyed solid growth over the past three years, and the company continues to pay out greater dividends without yet running the risk of using up its free cash flow. Is investor optimism justified, or will Harris' bottom-line weakness catch up to it soon? Let's dig a little deeper to find out.

Harris has been struggling for more than a year to improve its top line because of declining defense spending, which represents more than two-thirds of its revenue. Consequently, Harris has recently endured a significant decrease in its order backlog. In an effort to combat these problems, Harris has expanded its business portfolio to accommodate high growth verticals and overseas markets. Fool contributor Katie Spence notes that Harris recently bagged a $92 million contract to supply 4G LTE base stations and tactical radios to a firm in the Middle East. Poland's Ministry of National Defense also awarded a $61 million contract to Harris for the supply of Falcon III AN/PRC-117G manpack and AN/PRC-152A handheld radios.

The company continues to gain major government contracts from the U.S., despite the sequester. Harris is one of several companies participating in a $4.1 billion defense contract to provide communications and transmissions systems to the U.S. Army. Competition will be fierce for these government dollars, but it would be a substantial windfall. AT&T (T 1.88%) and Lockheed Martin (LMT -0.20%) are also part of this contract, and their superior size could muscle Harris out of much of the project -- Lockheed generates nine times Harris' revenue, and AT&T is over 25 times larger, revenue-wise.

The Pentagon has also granted Harris a $140.7 million contract for the production of mid-tier networking vehicular radios for the U.S. Army, and Fool contributor Rich Smith notes that Harris' contract to maintain and support GPS antenna sites with the U.S. Air Force has been extended till September 2014. Earlier this year, the company received a $500 million contract to deliver radios and support equipment to the U.S. Army, which will be completed by the end of 2015. The government's response to sequester cutbacks in 2014 will be perhaps the single most important factor in Harris' progress next year. If the worst of these indiscriminate reductions are bypassed or revoked, Harris should be fine -- but if continued intransigence allows the sequester to bite deeper into government spending, investors can expect a weak 2014 for Harris.

Putting the pieces together
Today, Harris has few of the qualities that make up a great stock, but no stock is truly perfect. Digging deeper can help you uncover the answers you need to make a great buy -- or to stay away from a stock that's going nowhere.