Lockheed Martin: Dip Or Pause?

A few days ago, Jonathan Goldberg posted a bullish analysis of Lockheed Martin. He used his equity value per share model, combined with a 3% growth assumption, to come up with an intrinsic value of $108.50 per share. Since its current price of $74.95 is slightly below Mr. Goldberg's margin-of-safety entry point of $76, he concluded that it was undervalued.

This post is intended to be a complement to his own analysis.

Lockheed Martin is a well-known defense contractor, with about 93% of its revenues coming from the U.S. government. Its four segments are Electronic Systems, Information Systems and Global Services, Aeronautics, and Space Systems. The company has done rather well for itself over the last ten years, with the notable exception of 2000 and 2001. 10-year return on equity, as calculated by dividing a 10-year sum of net incomes by a 10-year sum of shareholders' equities, is 18.26% for 1999 t0 2008. Growth in continuing-operations earnings per share, as calculated by a brute-force method using 2008 and 1999's EPSs, was 15.26% over the same timeframe. Long term, the company's grown a fair bit.

Its presence in the Low P/E Bin could be explained by a combination of the recent bear market, creating fears that Lockheed's earnings will implode, and a new Democratic Administration that might cut back on defense expenditures. The first risk factor has not shown up in Lockheed's earnings, and the second has not made itself evident yet. There's only been a bit of an earnings slump relatively recently.

Nevertheless, Lockheed's performance in 2000 and '01 was disappointing. Continuing-operations EPS were -$1.05 and $0.18 respectively. Another major defense company, General Dynamics, suffered no such blow to its own earnings in that time. General Dynamics is no longer in the Bin, but recently it was.

A glance at Lockheed's 10Ks for the period show why the company got itself into the trouble that it did. A large part of the losses were the result of an abortive attempt to get into global telecommunications. It could have been caused by tech-bubble mania back then. No similar effort has been launched by the company as of now; as noted above, almost all of its revenue comes from the U.S. government. Given the company's standing as a defense contractor, that 93% is indicative of Lockheed management sticking to the company's knitting. They venturing beyond that confine didn't work out too well last time. As of 2000, only 70% of Lockheed's sales were made to the U.S. government. A year later, it had wound down its global-communications segment. It seems that Lockheed's earlier troubles taught it a lesson, subsequently learned.

Its latest earnings have seen somewhat of a slump. As of June 30th, according to its latest 10-Q, 2Q '09 diluted EPS were $1.88 as compared with 2Q '08's $2.15. Diluted EPS for the first half of '09 were $3.55 as compared with $3.90 in '08. In 2008, the last year of EPS growth, all quarterly EPSs were above the EPSs of the same quarters a year ago.

The order backlog is also rising, which ostensibly is good news. The backlog was virtually steady from 2001 to 2007, though: those years saw EPS growth much higher than the 10-year results. The last jack-up of the backlog was in 2003, and the following year saw EPS growth of 20.9%. On the other hand, the backlog grew smartly in 2000 and 2001. Both years were real disappointments for Lockheed. I don't believe that next year will be a repeat of 2001 because Lockheed has not moved beyond its core business this time 'round. I include this discussion to point out that a rising backlog isn't always as good as it seems.

Disappearance in EPS growth explains why Lockheed's in the Bin. Also, the company's growth over the last eight years came in large part from the wars the U.S has been in. Anyone buying this company as a growth engine at a discount is assuming that there will be similar compelling reasons for the U.S government to buy Lockheed's higher-margin products. It's an assumption that has good odds behind it, as post-WWII U.S. history shows, but it may not hold up during this Administration. The trouble with Lockheed is that its 3.04% dividend yield isn't that great, so there's not much pay for waiting. It has increased its dividend every year in the last six, but that growth took place in tandem with EPS growth. That growth can't be expected in the near future, even though its dividend is solidly covered.

Should this Administration and Congress turn out to be dovish, then Lockheed's earnings won't do all that much. However, there's nothing on the horizon to suggest future disaster will afflict the company. It may prove to be a churner, but there's no sign it's a disaster in the making.

Behavioral Finance Article In The Wall Street Journal Online

This article's already been picked up by Simoleon Sense, but I'm linking to it here because I want to highlight it as an easy-to-read introduction to cognitive and emotional biases that pop in when we invest or trade. It's called "The Mistakes We Make—and Why We Make Them," and it's by Meir Statman.

He spends more time on emotional biases than the usual intro. Regret is discussed thoroughly, but anchoring isn't mentioned. Prof. Statman has the gift of matching biases to investing activity we can all relate to; it's as if he had been there himself. He even ends with why a well-known investing technique gets around our regret bias. It makes for a good read.

David Dreman Says Double-Digit Inflation, Interest Rates Are Coming

One of the enduring themes of value investing is that what is out of favor today will be tomorrow's hot sector. David Dreman appeared on CNBC recently, advising people to load up on stocks that will likely benefit from inflation. Many of them are in currently beaten-down sectors like REITs and energy, which is currently being beaten down earnings-wise. He also recommended the strong names in the financials.

The CNBC blog post with his picks is here, and the webbed interview with him is available on the same page.


I'd like to thank VInvesting for posting this item first.


Update: If you have dial-up, as I do, the CNBC video is likely to be unwatchable. The same interview's at Youtube, as posted by Value Investing Pro, which can be loaded before it's played.

When I went over there, the Youtube version had a total of 82 views. Contrarians might be interested in that figure.

A Darned Good Point About Margin Erosion

In the blog "Reflections On Value Investing," Shai Dardashti puts forth a very good point about competitive moats that don't erode. Companies with high returns on equity, on the basis of a solid brand name, don't have their superior ROE eroded if the raw cost difference between the brand name and a cheaper alternative isn't enough to get many consumers switching. Why switch to the generic if it means only a $20 saving per year, unless it's important to you to shop at a discount? Some people do, but many don't. Others consider the risk of lower quality to be not worth saving a few bucks over, even if that risk is largely illusory.

It's a post that well worth reading, and thinking over, particularly if you're an economics graduate.

An Engaging History Lesson About The Panic Of '07

It's always a good idea to study previous market crashes to self-inoculate against the mania that precedes one. Mark Perkins over at Stock Pursuit wrote an essay on the causes of Panic of '07, with an interlaced biography. It's not only an interesting read in its own right, but it also was written in 2007; it ended with a forecast of trouble:

As an avid commentator and investor in equity markets I see parallels from 1907 to 2007. The trend of horizontal consolidation is still alive and well in the banking industry today though now flirting with anti-trust law. Big U.S. banks like Bank of America and Citigroup, though limited in their market share are making up for it by diving into speculative areas like mortgage backed securities. This is exactly like what the trusts in the late 19th early 20th century were doing. They were diversified but ended up taking on too much risk. The Banking Act of 1933 sought to limit banks in the scope of services like commercial and investment banking. When key financial institutions are involved in risky investments like in 1907 and the mortgage arena in the years leading up to 2007 there is going to be trouble. With portions of it lifted in 1999 this trend may have serious consequences.Risky, manic speculation driven by greed existed in the years before both. The current U.S. sub-prime loan crisis, which relates to risky loans granted during the recent housing bubble, is having an effect on the large financial institutions. This is strikingly similar to the risky loans issued by trusts in 1907. No one is sure how much the current crisis will spread into the credit markets. Where was the Federal Reserve and government regulation to reign in the capitalist environment? How can all these ridiculously risky loans be approved? Speculative investments fueled by greed will always exist. We cannot forget the Panic of 1907.

If only we'd been there at the time. The full article is here.

A list well worth reading and reflecting over

Brian over at Intelligent Investing has posted a list of traits every successful value investor has, broken into correct principles and correct personal habits. It's well worth reading over and relating it to your own experiences. I've found that rules of that sort don't really resonate without earlier sad experiences to relate to them.

Feel free to leave a tip of your own - I did.

A Dividend Model With Real Depth

The fellow behind Dividends Value has come up with a ranking system that goes into more depth that I had imagined possible. It's explained in this post, along with twelve stocks with five-star ranks. One of them is a member of the Low P/E Bin: The Chubb Corp.

I've noticed Chubb being recommended as part of a different 12-stock list, by another dividend expert. His post has propogated to VInvesting.

One caveat I should pass along: Barclay's downgraded Chubb two days ago. This Insurance NewsNet article title is pretty upfront about the reason: "Barclays Analyst Says Chubb Faces Big Potential D&O [directors' and officers' liability insurance] Losses." The analyst in question anticipates very busy civil courtrooms thanks to the recent credit crisis.