In this series, High Quality Dividend Growth Stock of the Month, I cover really great companies.
To identify them, I use my Quality Snapshot grading system. In a nutshell, here’s how the system works.
First, I research ratings and grades from sources that I have come to trust and respect over the years:
- Safety and Financial Strength grades from Value Line
- S&P’s Credit rating
- Morningstar’s Moat rating, and
- Simply Safe Dividends’ Dividend Safety grade.
That gives me five factors that address, each in their own way, company quality.
Then, because the sources use different grading scales and systems, I assign points to their various approaches that let me unify the different rating systems into a single system.
As you can see, each factor can get up to 5 points. The Quality Snapshot score for a company is the total of its points, so the highest possible score is 25 points.
Finally, to interpret those total scores, I use the following ranges.
April’s High Quality DG Stock: Lockheed Martin Corporation (LMT)
Lockheed Martin Corporation (LMT) is a global defense and aerospace giant. As I’ll discuss in a minute, Lockheed Martin scores 24 out of 25 points in its Quality Snapshot.
Headquartered in Bethesda, MD, LMT serves both U.S. and international customers with products and services that have defense, civil, and commercial applications.
LMT’s principal customers are agencies of the U.S. Government. In 2020, 74% of the company’s $65.4 billion in net sales were from the U.S. Government, mainly the Department of Defense; 25% were from international customers; and 1% were from U.S. commercial and other customers.
Lockheed Martin’s main areas of focus are in defense, space, intelligence, homeland security, and information technology (including cybersecurity).
This is Trefis’ breakdown of LMT’s business, showing its four business segments.
LMT’s largest segment, Aeronautics, covers military aircraft, including the famous F-35 Lightning II Joint Strike Fighter, now in its 5th generation. The F-35 is LMT’s largest program, generating 69% of Aeronautics sales and 28% of LMT’s total sales. The F-35 stealth fighter took nearly 20 years to develop and reached initial operational capability in 2015.
Lockheed Martin’s High Quality
Lockheed Martin’s Quality Snapshot is a thing of beauty. It gets the maximum of five points in every category except for its credit rating, where it gets four points, giving it a total of 24 out of a possible 25 points.
Fewer than 30 companies that I have examined get 24 or 25 points on this system, so LMT’s score of 24 places it in the top tier of all companies based on its quality.
Lockheed Martin’s Dividend Record
Lockheed Martin yields 2.8%, which is toward the lower end of what I consider mid-range (2-4%). Its 5-year dividend growth rate has been 10% per year, which is fast. That combination of yield and growth makes LMT a mid-yield, fast-growth DG stock.
Lockheed Martin’s dividend record is good. I give it a “B.”
LMT’s yield – at 2.8% — is a mid-range yield. While 2.8% is not super-high, that is balanced by its fast growth rate, which has averaged 10% per year over the past 5 years.
LMT’s dividend safety score of 84 points on Simply Safe Dividends’ scale of 0-100 is in the top tier of SSD’s scores. It means that LMT’s dividend is very safe and unlikely to be cut.
LMT has not declared its increase for 2021. Its latest increase – last December – was 8.3%, which falls into the “fast” range for a stock yielding 2.8%.
The company’s increases have slowly declined over the past several years, which is OK considering that the overall speed of growth is still fast. On the chart, the slowing growth rate is barely perceptible.
Lockheed Martin’s Valuation
To value a stock, I use four valuation models, then average them. For more details, see Dividend Growth Investing Lesson 11: Valuation.
Models 1 and 2: FASTGraphs P/E Benchmarks
FASTGraphs present a stock’s price on the same chart as valuation reference lines for easy comparison. I use two reference lines to denote fair value.
- A magenta reference line based on a standard P/E ratio for most stocks that I set at 18 to reflect “the market” over the past 20-30 years.
- A blue reference line based on the stock’s own P/E ratio for the past 5 years.
Here is the FASTGraph for LMT using an 8-year display period. (The 8-year display causes FASTGraphs to use the stock’s 5-year average P/E for the blue line.)
As it turns out, the blue and magenta lines are drawn at practically identical values, so the blue line covers the magenta line. The black line is LMT’s actual market price.
LMT is in a “dead money” phase where its price has almost flat since the beginning of 2018 even though the company has registered strong earnings growth (see the highlighted annual increases in EPS).
The flat price simulataneous with rising earnings has caused LMT’s P/E ratio to contract from about 24 three years ago to 14.9 today.
I create valuation ratios for each model that relate the reference P/E to the stock’s actual current P/E.
Valuation ratio #1 (magenta line) = 14.9 / 18 = 0.83
Valuation ratio #2 (blue line) = 14.9 / 17.9 = 0.83
Both models suggest that Lockheed Martin is undervalued. The dead-money market in LMT’s stock has taken it from overvalued to undervalued in three years.
Model 3: Morningstar’s Discounted Cash Flow
Morningstar takes a different approach to valuation. They ignore P/E and other common valuation ratios.
Instead, they use a discounted cash flow (DCF) model. That means that, using conservative projections, they discount all of the stock’s estimated future cash flows back to the present to arrive at a fair value estimate. The idea is that a stock’s fair price is equal to the net present value of all of the company’s future cash flows.
Here is Morningstar’s valuation of Lockheed Martin. The red line on the graph is Morningstar’s fair-value calculation over the past 10 years, while the black bars represent LMT’s price. You can see LMT’s fall from overvalued to undervalued on this chart too.
Morningstar’s model suggests that Lockheed Martin is undervalued. It shows the price-to-fair-value ratio as 0.86.
Model 4: Current Yield vs. Historical Yield
The final model compares the stock’s current yield to its historical yield.
If a stock is yielding more than its historical average, that suggests that it is a better value than usual, because you are paying less for the stock’s dividends.
We can see the yield comparison on this graph from Simply Safe Dividends. Lockheed Martin is currently yielding more than its 5-year average.
Again with this model, we make a valuation ratio. LMT’s current yield is 2.8% and its 5-year historical average is 2.6%.
Valuation ratio = 2.6% / 2.8% = 0.93
Because that is within 10% of 1.00, I call that “fairly valued.”
To arrive at my overall valuation, I simply take the average of the four models.
The aggregate assessment is that LMT undervalued, with a valuation ratio of 0.86. Using that ratio, it is easy to calculate a fair price:
Fair price = current price / valuation ratio.
Lockheed Martin’s recent price is about $371. Using the formula for fair price, we get $371 / 0.86 = $431.
All valuations are estimates about the future. Therefore, it is logical to think in ranges rather than precise values.
I regard any price within +/- 10% of my calculated fair price to be “fair.”
If I apply that 10% cushion to LMT, that puts the top of its buying range at $475.
Obviously, with LMT currently trading so far below its fair price, there is no need to even think about its maximum buy price. A good time to buy it is right now.
I own Lockheed Martin in my Dividend Growth Portfolio. In fact, I have been building up my position since late last year. As an accumulator of the stock, LMT’s dead-money era and lack of upward price movement over the past three years is fine with me.
In researching this article, I could not help but notice the high ratings that Lockheed Martin has from a number of different sources. For example, here is the summary of research provided by E-Trade to its customers:
Besides being in my portfolio, Lockheed Martin is a holding in DTA’s Income Builder Portfolio. For Mike Nadel’s thoughts when he last added to that position, see this article: We Just Bought Lockheed Martin (LMT) for DTA’s Income Builder Portfolio (July 2020).
Jason Fieber has also written about LMT’s attractive valuation: Undervalued Dividend Growth Stock of the Week: Lockheed Martin (LMT) (October,2020)
This article is not a recommendation to buy, sell, hold, trim, or add to Lockheed Martin. As always, perform your own due diligence. Check the company’s complete dividend record, business model, financial situation, and prospects for the future. Also consider your tolerance for risk, and especially consider how well the company fits (or does not fit) your long-term investing goals.
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This article first appeared on Dividends & IncomeWe’re Putting $2,000 / Month into These Stocks
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