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Investors are pushing sector rotation toward more cyclical sectors and the former defensive leaders are lagging. Industrials are underperforming, with the aerospace and defense industry outgunning both the sector average and also the S&P 500 in total return year to date. Thomson Reuters StarMine has identified four aerospace and defense firms with strong characteristics: higher levels of earnings sustainability, analyst revisions, intrinsic and relative valuation, and price momentum. They are: Boeing (BA), General Dynamics (GD), Lockheed Martin (LMT) and Raytheon Co (RTN).

In spite of the industrials sector underperforming the S&P 500 in total return year to date (14.3% vs. 15.4% -- see chart below), the aerospace and defense group (red line) rocketed up 17.4% through May 10. After some hesitancy about Boeing's 787 Dreamliner battery issue plus the impact of the budget sequester in this industry, investors embraced moves up in early March and mid-April. Of the industry's 11 names, StarMine identified four that rank in the top 20% of all U.S. companies in two categories. The first is Value-Momentum (Val-Mo), which combines two valuation (intrinsic and relative) and two momentum (price and analyst revisions) models. The second is Earnings Quality, which measures the degree to which past earnings may be sustainable into the future. Equity investors may salute the fact that more than one model ranks these stocks among the top 20% of all U.S. stocks.

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Looking under the hood

The following are some takeaways from the models mentioned above. Note that the model scores range from a low of 1 to a high of 100 with 50 as average among U.S. companies.

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  • Reasonable analyst revisions scores prevail among all companies, with Boeing (78) and Lockheed Martin (70) as the highest on the list. Investors at times will continue favoring companies whose estimates are revised higher than others. The StarMine Analyst Revisions Model (ARM) takes into account four components of analyst revisions: primary and secondary earnings, revenues and recommendation over multiple time periods.
  • Average Price Momentum (PM) scores exist for all these companies except Boeing, which is already high at 81. One way to look at this is that the stocks have not run up as much as some of the better performers. The PM model accounts for long-, medium- and short-term price momentum as well as industry momentum.
  • Reasonable to Very Good Relative Valuation Model (RV) ranks again except for Boeing, whose 56 score is around average but not over-valued (which would create a low score here). Six popular ratios are considered here using a rolling 24-month (trailing 12 and forward 12) time frame, including enterprise value/sales, enterprise value/EBITDA, P/E, price/cash flow, price/book and dividend (or buyback) yield.
  • Price/Intrinsic Valuation all above average for all companies, using StarMine's dividend discount model approach that adjusts for known analyst estimate biases. None of the companies here appears to be remotely overvalued by this measure.
  • Outstanding Earnings Quality (EQ) scores EQ measures the degree to which past earnings are sustainable into the future, and credits companies that avoid accounting maneuvers such as accruals and exclusions to boost their earnings. Three companies scored in the top 10%, including Lockheed Martin placing with a 97 out of 100 score. EQ's four components account for: accounting accruals, cash flow, operational efficiency and exclusions.

Summary

The jury is still out as to whether the shift in the market since last April towards favoring cyclical stocks may or may not turn into a sustainable sector rotation. Regardless, the four companies highlighted above maintain average to high positions relative to other industrials sector companies and all U.S. firms.

Source: Sector Rotation Favors Aerospace And Defense