This analysis evaluates Lockheed Martin (LMT) stock, concluding that it is currently undervalued based on discounted free cash flow and historical price-to-earnings multiples, with a significant backlog and strategic acquisitions bolstering its financial outlook.
hi i'm jimmy in this video we're going to run through a quick analysis of lockheed martin stock
ticker symbol lmt now lockheed martin is one of the companies that are leading one of the polls
in our membership group for this channel plus a whole bunch of people put up comments saying
that they believe that lockheed martin stock is undervalued at this point so let's take a peek
first we're going to start with a quick review of lockheed martin's business look at some news
and then we're going to dive into a fair value calculation using discounted free cash flow okay
so let's jump right in so i think a logical place to start is where lmt generates the revenue and
clearly the biggest takeaway here and probably not a very surprising one is the fact that in 2020 the
us government accounted for 74 percent of lockheed martin's revenue now when we look over at their
segments well lockheed martin's largest segment is aeronautics which accounted for about 40 percent
of revenue in 2020. the aeronautics division designs and manufactures military aircraft
mostly for the us air force and the u.s navy then the rotary admission system segment generated
about 25 percent of revenue last year now this division makes military and commercial helicopters
they do uh surface ships sea and land-based missile systems they have radar systems
and the list goes on and on then the space segment will they account for about 18 percent of revenue
and what they do is that they make satellites uh space transport vehicles strategic strike
and defensive systems and again the list goes on and on as far as what this division com does we'll
come back to this one in a second once again this the most of their products are being sold to the
us government and finally they have the missiles and fire control division they create uh missiles
defense systems they have tactical missiles uh air-to-ground missiles they have some fire control
systems they have manned and unmanned vehicles and as expected the us government accounted for
about 75 of this segment's revenue okay so now we have an idea of what lockheed martin does
from a business perspective now let's look at some recent developments and some key takeaways
from some of the research i've done on lmt stock now one point that i think is important is that
lockheed martin has an excellent backlog of business so what we can see is that
as of the end of 2020 well lockheed martin has about 147 billion dollars worth of back orders
and given that lockheed martin in 2020 put up about 65 billion in total revenue well clearly
this backlog is quite large and likely a good sign for business over at least the next few years
now many investors are expecting that defense spending is going to stay either flat or even
slightly down over the next couple years so it's likely that this backlog stops some of the rapid
increase that we've seen in recent years over the next few years maybe it levels off maybe it
drops down a bit so this is a good sign for their financials now on a separate note right at the end
of 2020 lockheed martin announced the acquisition of aerojet rocketdyne they're a well-established
rocket and missile propulsion manufacturer and this acquisition is expected by no surprise
expected to help their lockheed's current missile defense programs it should help
lower some of their costs and make the division a bit more efficient which is great could improve
their overall margins but lockheed martin is really hoping that this will give them more
opportunities in the space division which clearly is becoming a hotter and hotter space right now
between the recent landing on mars that nasa did and everything going on with spacex so space is a
hot place to be right now and lockheed martin is hoping that error jet rocketdyne helps push their
objectives forward there now aerojet rocketdyne also helps lockheed's hypersonic weapons system
which the us navy has already awarded lockheed martin a big contract just recently they
announced a big contract for long-range hypersonic weapons so this is right in line with what aerojet
rocketdyne brings to the table so i think that this acquisition was a smart one this should help
put their business it should help push some key segments of their business forward specifically
space but it really helps a lot of different divisions so i think that this was a smart
acquisition for them to make now when we look at their revenue well we can see that lockheed
martin's revenue has done a good job of moving higher consistently over the past few years and
analysts are expecting for that growth to continue analyst expectations are the ones in the green
bars and then when we switch over to lockheed martin's profits or we can see that the broad
trend of net income or profit that's the same thing well that's been positive as well so these
are both positive signs for lockheed martin's business okay now we shift over to free cash flow
so free cash flow this is a free cash flow going back to 2014 and as we could see broadly speaking
just like net income well free cash flow has fairly consistently moved higher now of course
we could see 2018 was the main exception so i read through the annual report for 2018 and it turns
out that free cash flow dropped in 2018 because after the 2017 tax cuts went into effect in the
united states well lockheed martin made a much larger payment towards their pension account just
to give a point of comparison in 2017 well they contributed just about 46 million dollars towards
their pension account but in 2018 they paid about 5 billion dollars towards the pension account and
i think in 2019 they paid about a billion dollars so in 2017 they probably knew 2018 was going to
be a big year and they were waiting for some tax benefits but because because pension contributions
count as cash flow from operations well that will affect free cash flow higher benefit higher
payments towards uh pension benefits and you end up with a lower free cash flow now it seems that
this was just a one-off because we could see the rest of the numbers are fairly consistent
okay now we're going to use analyst estimates for free cash flow and we're going to shift over to
our calculation of lmt's discounted free cash flow what do we think is the fair value and i'm not
going to run through how this calculation works since i created a whole video on how to do this
whole thing this is an excel template i created i'll leave a link to the just in i'll leave a
link in the description below to that video but basically what we do is we take analyst estimates
we discount that by a required rate of return in this case i'm using 7.5 i've been using seven and
a half percent for about a year because that seems to be a reasonably a reasonable amount
above what we would get and let's say something like corporate bonds and then i used a perpetual
growth rate of two and a half percent and that gave us a fair value for lockheed martin stock
of about 491 dollars per share now lockheed martin does have some debt and some cash so we're going
to want to adjust this calculation when we do that what we can see that we now get a discounted
free cash flow calculation our fair value of 455 dollars per share and given that the stock
is currently trading at about 340 dollars a share well looks like people were correct when they said
lockheed martin looks to be undervalued right now plus on top of this i was curious and their
price to earnings multiple right now is about 11.5 times earnings to put that in perspective
the s p 500 is currently trading at about 32 times earnings now i didn't want to just take
that pe multiple compared to the s p 500 and say okay yeah it's definitely undervalued so i was
curious about how the pe multiple has been over let's say the past two years so i put together
this chart where we look up the previous 12 months earnings compared to the price on any given day
and the average price to earnings multiple over this entire two years is about 14x now i bring
this up because it's easy to look at the s p 500 and say well you know lmt is trading below the
average for the for the s p 500 therefore lmt is undervalued that's not really a fair way to do it
because we can see that lmt over the past two years has never really traded anywhere near the
s p 500 so looking at their own history they still look undervalued compared to where the
numbers are today so again this verifies what many investors thought that this stock looks
to be undervalued right now now if we shift over to a chart for lockheed martin stock
well our discounted free cash flow calculation puts lmt's fair value up here at 455 dollars per
share if we use the average pe multiple over the two years well we end up with a fair value close
to about 416 dollars per share so that's what the pe multiple is saying it should where it should be
and discounted cash flow is above that so which one is better well this is really a preference
thing i personally prefer generally discounted free cash flow i like that i think that's a better
valuation method but if the long term average for lmt's p e ratio had been somewhere let's say down
here well i would have been much more hesitant about using my discounted cash flow calculation
i love the fact that they're both actually up here and they're both sort of verifying that the stock
looks undervalued so maybe we take an average maybe we take the low one maybe we take the higher
one it almost doesn't matter personally i i am i i prefer to be more conservative so even though
i like discounted cash flow better i'm gonna personally use the lower version the 416 because
i'd rather be conservative just in case i'm wrong now one additional perk to lockheed martin's stock
is that they also pay a dividend right now they have a dividend yield of about three percent
so that's a pretty good thing for many people i like dividends so i'm happy that this stock pays
a dividend now one of the most important questions is okay we like the stock up there it's down here
what is a fair margin of safety to buy this stock at so basically the concept here is
that we know that both discounted cash flow and pe multiples are estimates they could be wrong
so how much leeway are we willing to give our calculations right now the price to earnings
multiple is about 23 higher than the current price our dcf calculation is about 35 percent
higher than the current price so according to my own investing rules this is enough of a margin of
safety to jump in and buy lmt stock so if you're curious yes i will be personally buying l t stock
in the near future now i have a personal rule that i won't buy a stock after i make a video on it
for at least a few days after that video has been published now i'm planning on publishing the video
probably over the weekend probably saturday so for me first trading days monday i think it's
reasonable to wait till let's say thursday or friday before i jump in and buy it so assuming
nothing crazy happens between now and then yes i will be jumping in i'm personally buying lmt's
lmt's stock since it is at least 15 below our calculation of fair value in my example i'm using
the price to earnings multiple because that is a more conservative version had the discounted cash
flow calculation been lower well then i would have used that one instead because again that would
have been more conservative now if you're curious how i came up with the 15 margin of safety that
i'm applying to this calculation well i actually did a video where i go through when to buy a stock
so if you're interested perhaps that could be a good next video for you to watch i got a link
right here i got a link in the description below and thank you so much for sticking with me all the
way to the end of the video i really do appreciate it thank you and i'll see in the next video
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