Streetwise for Friday, November 16, 2018

As you are inundated with a plethora of forecasts as to what Wall Street might or might not do going forward, and you will be, remember that the driver of daily stock prices is not earnings, it is fear, hope and greed.

In the short-term, those three emotions will often counteract and override such corporate fundamentals as product analysis, research and development programs, customer demand, supplier relationships, and management expertise. However, long-term it will always be a corporation’s financial performance that becomes the determining factor.

Therefore, to be successful you will need to undertake a degree of fundamental financial research. Attempting the easy way out with the likes of mutual funds and/or exchange traded index funds (ETFs) will never enable you to achieve the same success as investing in individual equities.

So, where do you start? One possibility might be General Dynamics (GD), a major player in the defense arena. Headquartered in Falls Church, Virginia, General Dynamics is a global aerospace and defense company that offers a broad portfolio of products and services in business aviation, combat vehicles, weapons systems, munitions, and shipbuilding.

In analyzing at the company, it is immediately apparent that the shares are down 9.9 percent year-to-date. So why the pummeling?

While the company reported revenue of $9.09 billion in the most recent quarter, as compared to $7.58 billion in the third quarter of 2017, the Street was looking for $9.38 billion. Did it ever occur to anyone that perhaps the Street was a little over ebullient in its projection?

General Dynamics did say that a large portion of its revenue increase for the third quarter came from its acquisition of CSRA. However, the company also pointed out that revenues increased throughout its other business segments.

On a more positive note, net income for the third quarter was $851 million, far better than the $754 million reported a year ago, while earnings per share were $2.89, as compared to $2.52 a year ago. Analysts were expecting $2.76 per share.

Operating earnings for the third quarter came in at $1.14 billion, as compared to $1.06 billion a year ago.

Yes, General Dynamics has been a valuation laggard among large defense companies. So, is there an outlook for improvement going forward?

The Gulfstream division like its competitors has never fully recovered from the 2008-2009 recession. However, the outlook for private jets going forward is improving.

Gulfstream was also hurt by the July bankruptcy of supplier NORDAM Group, a maker of the nacelles for the engines on the upcoming G500 and G600 models. Gulfstream acquired the manufacturing line last September to try to ensure continuing production, but the transition has caused delays.

The result has been a sales advantage to its rivals. However, Gulfstream’s sales growth should accelerate in 2019, with improved profitability. The bottom line is that Gulfstream is on the mend and should generate double-digit earnings growth by 2020 if not 2019.

On the military side margins were down for the quarter, the result of early-stage spending for future programs. Yet, large-ticket defense items tend to improve in profitability over time.

General Dynamics reported an overall backlog of $69.53 billion, an increase of more than $3.24 billion from second quarter, and an increase of $5.6 billion from the year prior.

Benefitting from geopolitical instability, the company’s shares have tripled over the past five years. The company has also increased its dividend for 25 consecutive years.

Finally, if a possible market correction concerns you, consider that during the Great Recession, General Dynamics posted the following earnings per share: 2007 $5.10, 2008 $6.13, 2009 $6.20 and in 2010 $6.82.

The intrinsic value of the shares using a free cash flow to the firm model is $172.78, which is currently lower than we want. Nonetheless, my 2018 earnings estimate is $10.25, with a 12-month projected share price of $225.

Lauren Rudd is a financial writer and columnist. You can write to him at LVERudd@aol.com. Phone calls accepted between 9 AM and 3 PM at (941) 706-3449. For back columns please go to www.RuddInternational.com.