The recent launch of the Orion flight test signifies one giant leap for the United Launch Alliance's mission to get man to step outside earth once again. The United Launch Alliance is a partnership between Lockheed Martin Corp (LMT, Financial) and Boeing (BA, Financial) to provide spacecraft launch services to NASA, the Department of Defense and other organizations. It also provides one small step for a value investor to better understand the investment potential of Lockheed Martin Corp.
The first step to understanding Lockheed is to study how it makes money. The products Lockheed produces and the historic growth in revenue are aspects one must be familiar with. Gurufocus provides a business description and other statistics on the Lockheed Martin summary page. On the Interactive Chart page you will be able to plot this revenue figure. Observe historical growth in revenue. Notice the declines and identify the short-term and long-term business cycles of this company.
Since investors are looking to purchase revenue, the next step is to study the price paid for that revenue. As with the price of fuel used to power the rocket changes with supply and demand, the price of Lockheed Martin's revenue also moves with investor sentiment. In 2000 and 2011 the price of Lockheed's revenue was near the low range of the past 20 years. Some value investors believe buying near Price to Sale lows present a "margin of safety." Just like when we notice lower gas prices at the pump we find an opportunity to buy, the P/S ratio is often an opportunity to buy gauge for equities.
The next aspect is to understand margins, their historic range, and how it affects "owner's earnings." Being familiar with how little is remaining after all the costs of business are considered is paramount to an enterprising investor. With a net profit margin at 6.6%, LMT is only keeping about $0.07 out of every $1.00 sold. If we consider the price paid for revenue is $1.30 and the company only keeps about $0.07, the equity investor's "owner's earnings yield" is 5.3% ($0.07/$1.30).
Many investors believe profit margins are mean reverting. A society that encourages competition will naturally have businesses migrate towards high margin opportunities. As high margins present opportunity, a flood of businesses will enter the market and fight for the same business. This competition will eventually create downward pressure on margins. A society that does not encourage this competition will often see businesses take advantage of customers. Innovation will also be stymied because the lethargy created by a non-competitive business system. Witnessed by Lockheed's 6.6% margins, a number in the 90th percentile of its historical range, competition will be coming soon. If margins revert to historical averages, that "owner's yield" would be even lower.
The next aspect in understanding Lockheed Martin is the dividend yield, a derivative of the Price to Sales ratio.
Astute investors understand how important dividends are to the total return of their portfolio. At his annual shareholder meeting, Warren Buffet often speaks of the importance of receiving dividends. In fact, much of the stock market returns of the past 100 years are due to reinvesting dividends. The reason why gurufocus states, "buying stocks at [a] higher yield relative [to] its historical values is more profitable" is because this high yield is often correlated to times when revenue was priced at a bargain. Notice how Lockheed's P/S ratio was low when the dividend yield was high in 2000 and 2012.
The bargain price of sales and high dividend yield attracts institutional investors like banks and insurance companies. In turn, as the whole market demands those high yields and low prices, the stock price ends up rising due to the competition for the yield.
With the recent liftoff of Orion, the Price to Sales ratio of Lockheed has also skyrocketed.
Does this high Price to Sales ratio explain why Hotchkis & Wiley, a $27 billion investment firm tracked by GuruFocus, has recently sold out of their LMT position?
For the recent launch, let us pray for a safe landing. For those investing in Lockheed Martin, let us use Gurufocus to protect us from a failed investment mission.
