Northrop Grumman "veiled" a new stealth bomber at last year's Super Bowl. On Tuesday, the U.S. Pentagon "unveiled" Northrop Grumman as the winner of the B-3 Bomber contract. Image source: Northrop Grumman video stillI..

Northrop Grumman (NYSE:NOC) shares rocketed 7.4% in early Wednesday trading, as investors got their first chance to react to Tuesday evening's amazing news that Northrop has won the B-3 bomber contract. But then, Northrop dropped its other bombshell of the week, reporting its earnings for the fiscal third quarter -- and the stock promptly gave back one-quarter of its gains.

So what went wrong?

The earnings news
As it turns out, actually, very little went wrong for Northrop Grumman last quarter -- and a whole lot went right. According to the company's press release (inexplicably withheld from the wire services but posted on the company's own website and also with the SEC), Q3 2015 saw Northrop Grumman:

  • hold the line on sales, which were essentially flat year over year at just under $6 billion
  • expand operating margins by 40 basis points, to 13.3%
  • and grow earnings 9%.

Profits per diluted share, meanwhile, surged 22% thanks largely to a 10% decrease in share count, which concentrated the growing earnings among fewer shares outstanding. Free cash flow has also turned positive for the year, helped by the $455 million in cash profits produced in Q3. (Both year-to-date and Q3 free cash flow, however, are down significantly from 2014 levels, thanks to about $500 million being diverted into a pension fund contribution.)

Perhaps best of all, Northrop Grumman is boosting its guidance for the rest of this year to incorporate the good news from Q3. As of now, Northrop Grumman is projecting that full-year earnings will range between $9.70 and $9.80 per share.

Valuation-wise, this suggests that at its current share price of $190 and change, shares of Northrop Grumman are selling for about 19.5 times current-year earnings. That's a pretty optimistic valuation, given that analysts who follow the stock still see Northrop growing earnings at only about 7% annually.

On the other hand, if Northrop manages to defeat challenges to its B-3 bomber contract win, and retain control of that contract (valued variously at anywhere from $55 billion to $90 billion over the course of decades), it's likely that analysts will soon be upping their estimates of Northrop's growth prospects.

On the third hand, considering that Northrop Grumman has so far generated just $195 million in positive free cash flow this year, the company's valuation looks even less attractive when valued on free cash flow than when valued on GAAP earnings. Indeed, if we project free cash flow based on the company's run rate for the year to date, I get a valuation of 137 times free cash flow on the stock -- which is clearly very expensive no matter how fast Northrop Grumman ends up growing.

Long story short, the week so far has been very kind to Northrop Grumman, and to the investors who own its stock. Given the rich valuation the stock now enjoys, however, the future may be less kind.