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Defense Stocks: Are They Overpriced Again?
How much should defense stocks cost? In 2017, I analyzed this question and found that historically, U.S. defense stocks traded at a valuation of almost exactly 1 times sales over a long period of 17 years.
This substantial dataset indicated to me that when major defense stocks were trading closer to 1.6, 1.7, or even 1.8 times trailing sales in 2017, they appeared overvalued. As a result, I recommended that investors steer clear of defense stocks that year.
Was that the right call? The answer varies depending on which stock we’re discussing.
Image source: Getty Images.
An Analysis of Boeing and the Defense Sector
Back in February 2017, when I wrote that article, shares of Boeing (NYSE: BA) were valued at about $177. As of now, Boeing shares are hovering around $150. So, in this instance, I believe I was correct. But how did other defense companies fare during this same period?
In the chart below, I detail the performance of 10 well-known defense stocks over the last seven years. This comparison will help us understand how they performed against the S&P 500 during that timeframe:
Data source: Yahoo! Finance.
The results may surprise you—four of these stocks saw their prices double and one even tripled, with nine successful investments against just one that failed. However, during this period, the average S&P 500 stock rose by 143%.
Interestingly, almost all of the defense stocks listed had underperformed the S&P, even though two significant military engagements were ongoing and a competitive arms race was visible in the South China Sea. Despite favorable conditions for defense stocks, most lagged behind the broader market.
This suggests I was right in my assessment from 2017: defense stocks were priced too high then. What’s more troubling is that they appear overpriced again today.
Reevaluating Stock Valuations
How can I support this assertion? Let’s consider an alternate viewpoint. Suppose, despite previous evidence, I was incorrect in 2017. If the usual valuation for a defense stock is not 1 times sales but a higher figure, we still need to investigate current valuation trends.
I revisited the price-to-sales ratios of these 10 major defense stocks, analyzing their trends over the past decade and even further back into the previous ten years, culminating in a 20-year overview.
The data yielded the following results:
|
Average Enterprise Value-to-Sales Ratio (EV/S) From: |
|||
|---|---|---|---|
|
2004-2013 |
2014-2023 |
2003-2023 |
|
|
Boeing |
0.9 |
1.8 |
1.4 |
|
General Dynamics |
1.0 |
1.7 |
1.4 |
|
Huntington Ingalls |
0.5* |
1.1 |
0.6* |
|
Kratos Defense & Security Solutions |
1.0 |
2.2 |
1.6 |
|
Leidos Holdings |
1.5** |
2.2 |
1.3** |
|
L3Harris Technologies |
1.4 |
2.8 |
2.1 |
|
Lockheed Martin |
0.8 |
1.8 |
1.3 |
|
Northrop Grumman |
0.7 |
1.9 |
1.3 |
|
RTX Corporation |
1.4 |
2.1 |
1.7 |
|
Textron |
1.3 |
1.2 |
1.2 |
|
Average |
1.1 |
1.9 |
1.4 |
Data source: S&P Global Market Intelligence. *Huntington Ingalls data begins in 2011, the year Northrop Grumman spun off the company. **Leidos data starts in 2006, and its average enterprise value-to-sales ratio for 2014 is missing.
Subsequently, I assessed these stocks’ current valuations using both enterprise value-to-sales (EV/S) and the more commonly used price-to-sales (P/S) metrics to provide clarity:
|
EV/S Today |
P/S Ratio Today |
|
|---|---|---|
|
Boeing |
1.9 |
1.3 |
|
General Dynamics |
2.0 |
1.8 |
|
Huntington Ingalls |
1.1 |
0.8 |
|
Kratos Defense & Security Solutions |
3.4 |
3.3 |
|
Leidos Holdings |
1.7 |
1.4 |
|
L3Harris Technologies |
2.8 |
2.2 |
|
Lockheed Martin |
2.3 |
2.0 |
|
Northrop Grumman |
2.3 |
1.9 |
|
RTX Corporation |
2.8 |
2.3 |
|
Textron |
1.3 |
1.2 |
|
Average |
2.2 |
1.8 |
Data sources: S&P Global and Finviz.com.
The Implications for Defense Investors
The available data suggests that heightened global tensions typically imply a robust market for defense stocks; however, current valuations reveal a potential risk for investors. The key takeaway is that despite the perception of a booming defense sales environment, stock prices are elevated, leading to skepticism about their long-term growth potential.
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Military Stocks: Analyzing Current Valuations and Investment Recommendations
Military stocks are currently valued higher than in the past. Historically, defense stocks were assessed at only 1 times sales, but the considered “new” fair valuation now sits at around 1.4 times sales.
Though this shift may be acceptable, it’s crucial to note that every defense stock listed is presently priced above its average valuation over the past 20 years. As a writer focused on defense, I would prefer different data to enable further stock recommendations. Unfortunately, that’s not the case.
In summary, defense stocks are still overpriced, and those who invest in them today are likely to achieve lower returns than a standard index fund over the next few years.
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Rich Smith does not own shares in any of the stocks mentioned. The Motley Fool recommends L3Harris Technologies, Lockheed Martin, RTX, and Textron. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are those of the author and do not necessarily reflect those of Nasdaq, Inc.
