Cramer’s Best Defense Stock

“I like Raytheon. Last week when we were playing “Am I diversified?” I felt someone could have used a defense stock and I casually mentioned Raytheon because it’s not that expensive. I do, however, prefer Lockheed because Lockheed Martin’s got a 3.4% yield and that attracts me as it comes down…

Lockheed Martin is a buy. Now, a lot of people were disappointed by the last quarter, I say get a life. This is a company generating a gigantic amount of cash. It’s not expensive. It’s very well run. And as far as I’m concerned, this is the best bargain in the defense group. LMT, Lockheed Martin, pull the trigger right now.” — CNBC’s Mad Money 10/12/2009

As he often does, Mad Money’s Jim Cramer chose a theme for his show this week, and the theme will center on stocks related to national security. On last night’s show he discussed a lot of stocks related to defense and national security including Alliant Techsystems (NYSE:ATK), American Science and Engineering (NASDAQ:ASEI), Raytheon (NYSE:RTN). However, it was Lockheed Martin (NYSE:LMT) that he was most positive on, calling them the best bargain in defense.

At Ockham, we have to agree with his assessment of Lockheed, as the company shows up favorably on all of the six main factors that our methodology evaluates. Chief among these metrics is that the company is trading well below its historically normal ranges of price-to-cash earnings and price-to-sales. For example, over the past ten years a price-to-cash earnings range of 10x to 14.7x has been the level LMT has traded within, but as of our most recent data that metric is currently only 7.3x. It is a similar situation the with price-to-sales valuation metrics.

Also, we like the consistency in revenue growth for Lockheed Martin, which can attribute the vast majority of its revenue to government contracts. Revenue growth has been steady in the past, and barring something unforeseen it will continue in the mid single digits through fiscal 2010. As Cramer noted, the company is generating great cash flows, and they pay a very attractive dividend as well.

There are always concerns with this sector however, as more than 85% of income comes from the U.S. government. This company obviously is subject to any changes in policy that come out of Washington, which may make it too risky for some investors. Furthermore, Lockheed operates in a capital and debt intensive business, and although it looks more than capable of handling the near term requirements, the long term debt load is an issue as well. Also, Lockheed Martin has a massive pension obligation that is currently underfunded, which may put future profits in jeopardy.

With all of these concerns in mind, we are reaffirming our Undervalued rating on LMT. Of course, there are issues inherent to the company, but as of yet we think that the fundamental strength of Lockheed is just too attractive not to make it worthy of serious consideration. This stock has not taken part in the rally even though the fundamentals remain attractive; this is a positive for investors who are looking to deploy some resources into the market. For long term investors, the yield is large enough to allow them to have patience if it takes the market a little while longer to recognize the value of LMT.

Lockheed Martin: Cramer’s Best Defense Stock

About Ockham Research 645 Articles

Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

We utilize this straightforward approach to value over 5500 securities, with key emphasis given to the study of individual securities' price-to-sales, price-to-cash earnings and other historical valuation ranges. Our long term value investing methodology is powered by the teachings of Ben Graham and it has proven to be very adept at identifying stock prices that are out of line with fundamental factors.

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