Although I wish it weren’t the case, few countries can avoid having a military presence — which means that defense stocks will always have a ready list of customers. There are a host of notable players in the space, but right now I’d stick with the biggest and best companies. That’s a short list, but one name stands out to me: Lockheed Martin (NYSE:LMT). Here’s why.
The 800-lb gorilla
With a market capitalization of roughly $100 billion, Lockheed Martin is a huge company. It isn’t exactly the largest player in the space, with Raytheon Technologies, which has a large nondefense aerospace business, boasting a market cap of $130 billion or so. But most of Lockheed’s closest defense competitors (Northrop Grumman and General Dynamics) are much smaller. All in all, Lockheed Martin is more of a pure play and is the dominant defense-focused name.
Its business is spread across four segments: aeronautics (about 40% of sales), rotary and mission systems (RMS) (25%), space (18%), and missile and fire control (MFC) (17%). It has its fingers in all of the important areas of the military industrial complex. And while it has just one basic customer, the U.S. government and its approved allies, it serves multiple different end customers underneath that high-level umbrella, from NASA to each of the individual military services.
Notably, the contracts on which Lockheed works can span decades and provide billions worth of revenue over their lifespan. Right now, the company has a $141 billion backlog of future work on its books. That provides material clarity about the future, but is also a testament to the nature of military spending. Notably, Lockheed Martin has increased its dividend annually for nearly two decades, showing both its success and its commitment to returning value to shareholders. Its leverage is higher than peers’, with the debt-to-equity ratio at around 1.9 times. Yet given the company’s dominant size and diversification, I’m willing to accept this negative.
But these are all big-picture reasons for preferring Lockheed Martin to its peers. The chief reason I believe Lockheed is the best defense industry option right now is its relatively cheap valuation.
Looking at the top line, Lockheed’s price to sales ratio is roughly 1.5 times today. Its five-year average for that figure is about 1.7 times. Using the bottom line, the company’s price to earnings ratio is around 14 times compared to a longer-term average of 22. And focusing on the balance sheet, its price-to-book value ratio is 15.7 times, down from over 20 in 2020. Overall, Lockheed Martin looks like it is trading at a reasonable, if not discounted, price.
To be fair, direct competitors like Northrop Grumman and General Dynamics are also trading below their historical valuation averages on these metrics. And, in some cases, they even appear cheaper. However, given the size and diversification of Lockheed Martin, I’d rather stick with the relatively cheap industry giant than its relatively cheap smaller competitors. Adding to the allure, meanwhile, is the fact that Lockheed’s 2.8% dividend yield is at the top end of this trio.
The final call
If I were to buy a defense stock today it would be Lockheed Martin. That’s not to suggest that the other names in the space are bad investments, only that Lockheed appears to offer the best mix of risk and reward when you look at its scale, business mix, and valuation.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
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