The search was on for a most elusive beast.
Am I talking about Sasquatch? The Loch Ness Monster? An honest politician?
Nope. I’m talking about a high-quality company whose stock is reasonably valued.
Hey, I’m greedy: I want a company with a wide moat, a proven and sustainable business model, and a reliable, growing dividend. The whole shebang!
Such a beast is pretty rare … and it’s even more difficult to track down when the market just keeps rising, which is practically all it has done since the “coronavirus crash” bottomed out last March 23.
When the hottest names are speculative companies that show little or no profit but just keep getting bid up by investors — pulling most of the market up with them — it’s a challenge to find any stock that isn’t crazy expensive.
Any stock I actually want to pick for our Income Builder Portfolio, anyway.
Thankfully, I was determined, and I would not be denied.
Enter Northrop Grumman (NOC), one of the world’s largest defense companies.
Come Monday, Feb. 22, I will execute a purchase order on Daily Trade Alert’s behalf for about $1,000 worth of NOC.
Northrop Grumman will be the IBP’s 39th holding — and the third from the defense industry, joining Lockheed Martin (LMT) and General Dynamics (GD).
NOC = Nice & Cheap
I’ll get into how Northrop Grumman makes money in a minute. First, I want to talk briefly about the stock’s valuation.
As the following graphic from Simply Safe Dividends shows, NOC’s dividend yield of about 2% is considerably higher than its 5-year average (1.6%), and its forward P/E ratio of 12.6 is well below both its 5-year average (17.9) and the 21.4 P/E of its sector.
I’m not the biggest proponent of using 52-week highs and lows because I think it’s an arbitrary measure; but for those who do like that metric, Northrop’s current price is much closer to the low.
I will discuss valuation in much greater detail in my post-buy article, which is scheduled to be published on Tuesday, Feb. 23.
Getting (Even More) Defensive
If I wanted the Income Builder Portfolio to have a bigger stake in the defense industry, why didn’t I just decide to add to our Lockheed Martin or General Dynamics positions?
Well, each company does things somewhat differently.
Lockheed’s bread and butter is its F-35 fighter plane. GD has a large commercial air component.
Northrop specializes in missiles, warning systems, cyber-defense and space, as well as the continued development of its stealth B-21 bombers.
I like the idea of diversifying even within industries.
Additionally, because we already have invested more money into Lockheed Martin than into any other stock, and because General Dynamics was one of the IBP’s most recent buys, I wanted to go elsewhere with the next $1,000 semimonthly allocation.
The GBSD, which will replace the aging Minuteman III Intercontinental Ballistic Missile Weapon system, is expected to be completed by 2029 and then to be active through at least 2075.
The Pentagon is planning to spend upwards of $85 billion to build and deploy the system. You read that right: We’re talking about a program that will be a cash cow for NOC — and its shareholders — for the next half-century (and perhaps beyond).
While the sheer size of the GBSD project is notable, major commitments from the DoD are quite common for NOC.
Northrop Grumman’s sales for the 4th quarter of 2020 increased an industry-leading 17% from Q4 2019.
For the full year, adjusted earnings grew more than 11% over 2019, revenue was up 9% and operating income advanced 5%.
Looking ahead to 2021, Northrop is projecting double-digit-percentage sales growth in every segment, and 11% overall.
However, NOC expects earnings to be flat, or even a little down for 2021, partly due to pension-related challenges.
Earnings growth is projected to pick back up in 2022, and analysts are forecasting a 14% EPS increase for 2023.
As for performance and quality, Northrop Grumman has been a big winner. Over the last decade, its total return has been roughly twice that of the overall market.
Since the March 23 lows, the S&P 500 Index has significantly outperformed NOC — as well as most other industrial giants — due to the stellar showings of tech stocks and other companies positioned to take advantage of the pandemic.
But in the three years before that, Northrop Grumman bested them all.
The same was true for the 5 years, 10 years and 25 years leading to the 2020 crash … so I think it’s reasonable to believe that when a catastrophic event such as COVID-19 is no longer in the picture, Northrop again can be a dominant performer.
Value Line gives NOC its highest scores for financial strength (A++) and safety (1), and it includes the company in its model portfolio of Stocks With Above-Average Year-Ahead Price Potential.
Morningstar rates NOC a wide-moat business due to its long-term Pentagon contracts and the outrageously expensive barrier of entry into the industry.
Northrop Grumman has paid a dividend without interruption for three decades, and it has been growing its annual distribution for 17 years — mostly at a double-digit clip.
Simply Safe Dividends gives NOC an 80 score — the highest number in SSD’s “Safe” range.
Northrop’s free cash flow easily covers its dividend. Its latest quarter (circled) is no exception.
Our entire portfolio of dividend-growing companies, along with links to every IBP article, can be seen HERE.
Wrapping Things Up
Northrop Grumman is not really a corporate version of Bigfoot. After all, NOC actually does exist. (Great … now I’ve got Sasquatches mad at me!)
Still, Northrop’s combination of high quality, proven performance, reasonable value and dependable dividend growth makes it quite a rarity these days — and it will be a welcome addition to our Income Builder Portfolio.
As always, each investor is strongly urged to conduct his or her own thorough due diligence before buying any stock.
— Mike Nadel
This article first appeared on Dividends & Income
The goal? To build a reliable, growing income stream by making regular investments in high-quality dividend-paying companies. Click here to access our Income Builder Portfolio and see what we’re buying this month.