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Defense contractor General Dynamics Corp. (NYSE:GD) reported third-quarter earnings per share [EPS] that were above analyst estimates and 17 percent above the year-earlier level. Upside earnings surprises are nothing new for the company, which has generated EPS gains between 1 percent and 11.9 percent above expectations in each of the prior four quarters. Such earnings improvement sent us looking for other companies posting solid growth in the aerospace & defense industry.

We started off with the list of 71 aerospace & defense companies in the Reuters.com stock universe and focused on only those names appearing on the Reuters Select stock screens. There were four: Boeing Co. (NYSE:BA), Ceradyne Inc. (CRDN), HEICO Corp. (NYSE:HEI), and Precision Castparts Corp. (NYSE:PCP). (Click here to download an Excel spreadsheet comparing defense companies.)

Since we are looking for growth companies, we focused on the two firms that appeared on Reuters Select growth screens. Both HEICO and Precision Castparts appeared on the Rising Expectations screen, while Precision Castparts also appeared on the Accelerating EPS Growth screen.

To hone in on a single company, we focused on measures of management's effectiveness in using available capital to generate net income. Specifically, we filtered for the company that had the highest return on investment [ROI] relative to the industry norm over the last five years and in the trailing 12-month (NYSE:TTM) period. This is where Precision Castparts, which makes castings, forgings, and fasteners for aerospace, armament and industrial applications, pulled ahead, as indicated below.

PCP-Management-Effectiveness

The Accelerating EPS Growth screen filters for companies where the pace of improvement in EPS is improving. The Rising Expectations screen highlights companies that have beaten analyst EPS estimates in recent quarters. Given that both screens examine earnings, there is some overlap between the two.

The Rising Expectations screen begins by filtering for companies that have provided upside EPS surprises in each of the last four quarters. Over that period, Precision Castparts has trounced analyst estimates by a range between 1.7 percent and 16.2 percent, which it hit in the most recent quarter (MRQ) and represented a nearly 49 percent increase in EPS from the year-earlier quarter. Further, the actual earnings over the last four quarters enabled the company to post TTM EPS that is 43 percent higher than that in the year-earlier period. This acceleration in the rate of EPS improvement also enabled the company to satisfy a key criterion of the Accelerating EPS Growth screen: The rate of EPS growth in the MRQ period must be faster than the pace in the TTM time frame.

Looking closer, we find that EPS improvement has accelerated faster for Precision Castparts than it has for the industry average. Indeed, the company has gone from lagging the industry over the last five years to leading it in the TTM and MRQ periods.

Improvement in the company's already superior profit margins in the TTM span from their five-year averages was a factor in turning the company's revenue growth into the EPS gains that positioned Precision Castparts on the two growth screens. It was also a factor in registering the company on the Strong Operating Margins screen from the quality segment

PCP-Profitability-Margins

Both growth screens also take into consideration expectations for future performance and require some indication that growth will likely continue going forward. Specifically, they both necessitate that the present estimate for current-year EPS must be higher than the figure from eight weeks ago.

Over the last two months, the consensus estimate for 2006 EPS has climbed from $3.65 to $3.71. Analysts have also become more optimistic on the company's expected performance for next year; the consensus has risen from $4.31 to $4.41.

Given the company's fast growth and expectations for future gains, it is not surprising to see that Precision Castparts shares command a premium valuation on the basis of price to earnings (P/E). As indicated below, the company is priced slightly richer than the industry average for many traditional valuation metrics. And, finally, these factors also helped the company land on the High P/E Multiples screen in the sentiment arena.

PCP-Valuation

At the time of publication, Erik Dellith did not own shares of any company mentioned in this article. He may be an owner, albeit indirectly, as an investor in a mutual fund or an Exchange Traded Fund.

Note: This is independent investment and analysis from the Reuters.com investment channel, and is not connected with Reuters News. The opinions and views expressed herein are those of the author and are not endorsed by Reuters.com.

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Source: Precision Castparts: Exceptional Defense Company