AeroVironment (NASDAQ:AVAV) disappointed a lot of investors when it reported third-quarter earnings Monday. But it didn't disappoint me.

True, sales grew only 8%, and operating margins came in at a mere 8% -- results far short of the gangbusters growth of yester-quarter. True, too, AeroVironment management pulled back the throttle on guidance, and now projects it will book between $240 million and $250 million in sales this year, reaping at most $35 million thereon.

Funded backlog is up more than 100% over last year despite the recession, a fact which explains the extreme interest in unmanned aerial vehicles (UAVs) we've been seeing from defense industry stalwarts like Boeing (NYSE:BA), Textron (NYSE:TXT), L-3 (NYSE:LLL), and Northrop Grumman (NYSE:NOC). But no doubt about it, in the here and now, AV has significantly undershot previous guidance of low-20s growth.

Reality bites
So why do I find these numbers less disheartening than the Street? To learn the answer, you must travel back in time three months, and listen to what the company told us in December. I mean really listen -- not just skim the headlines and press the "buy" button when a single quarter glows green.

Listen:

  • "An increase [in] investments in [various operating costs would] ... bring our ... operating margin in line with our original targets for the year."
  • "The company closes ... many times ... between Christmas and New Years, reducing production during our third quarter. [As a] result ... our third quarters have been flat or down from our second quarters."

Thus, there was every reason in the world to expect profits to be down in Q3. And there may have been some irrational exuberance in shares rising up to ridiculous pre-earnings heights.

Where to from here?
So here we sit, one "bad" earnings report and 34% worth of lost market cap later, reviewing the carnage. Is it at least safe to buy AeroVironment now?

Maybe. Here's how I come at the problem:

Over the past three quarters, AeroVironment generated $12.1 million in free cash flow. Applied to current revenues, that makes for about a 7% cash profit margin on revenues. So, if AeroVironment is right about its full-year guidance, it should generate a total of about $17.2 million in cash flow this year. Trading at 24 times expected full-year cash flow and a 20% long-term growth rate, the stock looks a little overvalued to me. Personally, I'd prefer a steeper discount before buying more shares -- but we're getting close.

Learn everything you ever wanted to know about investing in UAVs in:

Fool contributor Rich Smith owns shares of AeroVironment and Boeing. AeroVironment is a Motley Fool Rule Breakers pick. The Motley Fool's disclosure policy folds easily into the original UAV -- a paper airplane.