Is there such a thing as an "earnings beat" that is bad news?

Raytheon (NYSE:RTN) shareholders learned the answer to that question yesterday, when the defense contractor reported first-quarter 2014 earnings that beat Wall Street estimates with a stick -- but then declined to increase full-year guidance at all. Here's how the numbers looked:

  • First-quarter revenue declined 6% year over year to $5.5 billion.
  • Operating profit margin expanded 240 basis points to 10.7%.
  • Profit from continuing operations climbed 26% to $1.87 per share.
  • Result: Net profit for the quarter came in at $1.89 per share, or 27% higher than last year's haul.

So far, so good, right? Now here's the bad news, and the reason Raytheon shares slumped 4% yesterday after the earnings report (and are down even more today): One-time items arising from tax and pension benefits skewed Raytheon's first-quarter profit upward, and that's not something we can count on happening again.

Absent these benefits, earnings for the quarter would actually have declined in comparison to the first quarter of 2013. Consequently, Raytheon is giving itself no credit for the earnings beat, is not raising guidance for the rest of this year to account for the bumper crop of profit collected in early 2014, and still expects for the year to earn between $6.74 and $6.89 per share in profit from continuing operations, on revenue of $22.5 billion to $23 billion.

What it means to investors
No increase in guidance on earnings doesn't mean no increase in earnings, however. In fact, even at the low end of guidance, the $6.74 per share that Raytheon is certain it can earn this year would be about 11.5% more than the company earned in 2013. It would be the difference between a stock selling for 14.8 times earnings today and a stock selling for 14.1 times the earnings it expects to have in pocket by year's end.

For a predicted 12.4% annual grower that pays a 2.4% dividend yield, that's a pretty nice price. The price is even nicer when you notice that over the past 12 months, Raytheon has generated more than $2.3 billion in positive free cash flow, which is about $200 million more than the company has reported for generally accepted accounting principles net income over the past 12 months.

Granted, this valuation depends heavily on Raytheon's ability to grow earnings at the expected rate. But given that the company booked $687 million more in orders in the first quarter of 2014 than it did in the corresponding period of 2013, and given that it's one of the very few defense contractors showing increases in the level of its funded backlog year over year (and only minimal declines over the past three months), I think the company's prospects for continuing growth look pretty good.

This, combined with the stock's attractive valuation, tells me that investors who sold off Raytheon stock in response to yesterday's earnings report may have jumped the gun. This company is doing just fine, and with a new and improved (meaning cheaper) stock price, it's even more attractive as an investment today than it was pre-earnings.