Lockheed Martin: Yield Squeeze

| About: Lockheed Martin (LMT)

Summary

Lockheed Martin hit new multi-year highs before reversing following strong Q2 earnings.

The defense and aerospace company has seen the dividend yield squeeze to multi-year lows as the stock has surged.

The recommendation is find a more appealing stock in light of the stretched multiples and low yields.

The strong quarterly results from Lockheed Martin (NYSE:LMT) continue a positive trend ongoing for years now. The defense and aerospace company has seen the stock surge during that time period stretching valuation multiples to new highs and pressing yields to recent lows.

Source: Lockheed Martin website

After the guidance raise, the stock made a big reversal on Tuesday going from a high of over $263 to a low of $252 due to concerns regarding the F-35 fighter jet program. Is this a signal to avoid the stock?

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Depressed Yields

Along with the Q2 report, Lockheed Martin raised the EPS guidance to a midpoint of $12.30. The number far exceeds the analyst estimates of $11.84. Note though, the stock closed the day all the way at nearly $260.

Beating quarterly analyst estimates are only one of many ways to value a stock. In this market, a solid dividend yield is highly valued by the market.

In this case, Lockheed Martin has seen the yield shrink over the years to only 2.5% now. Considering the company pays an annual dividend rate of $6.60 per share, the payout ratio exceeds 50% providing limited upside for raising the dividend in the near term.

The company is active in stock buybacks further limiting the upside potential of dividend hikes from the EPS bump. The dividend yield has declined from the attractive levels above 4% a few years back due to the huge gains in the stock over the last five years.

LMT Chart

LMT data by YCharts

Lockheed Martin even reduced the stock buyback big time compared to last Q2. The defense contractor only spent $501 million on stock buybacks during Q2 after paying $937 million last year. The quarterly amount used to repurchase shares fluctuates on a quarterly basis, but clearly Lockheed Martin didn't see a bargain stock during the quarter for a stock now worth $78 billion to spend a rather meaningless amount of $501 million.

In essence, Lockheed Martin returned an annualized rate of 5% based on the Q2 levels. The market is full of large-cap stocks with net payout yields (net stock buyback yields plus dividend yields) of over 15%.

Why Own Here?

The market is clearly in love with utility, telecom, and defense stocks that pay consistent dividends. The question at this point is why an investor would want to own the stocks at these levels.

Lockheed Martin trades at nearly 19x forward EPS estimates. Over the last five years, the stock offered the opportunity for a couple of years to buy the company at roughly 9x forward numbers.

LMT PE Ratio (Forward 1y) Chart

LMT PE Ratio (Forward 1y) data by YCharts

The good question is why own the stock at these levels. The only reason to stay involved is momentum. One can argue from the data above that Lockheed Martin could lose 50% of its value and stay in the normal valuation range. On the flip side, it seems rather unlikely that the stock eventually trades at a higher multiple.

Takeaway

The low interest rate environment is pushing people irrationally into a defense stock like Lockheed Martin at expanded multiples and lower yields. The current valuation is not justified by the fundamentals of the company. Investors will clearly get hurt eventually, but momentum could send the stock higher in the short term if the trading action wasn't a reversal signal today.

The recommendation is to look for better opportunities in the market.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.