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General Dynamics Corporation (GD), Northrop Grumman Corporation (NOC): Thursday’s Top Upgrades (and Downgrades)

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This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense, and which ones investors should act on. Today, with earnings season in full swing, we’re seeing mainly analyst reactions to earnings news. Specifically, today we’ll be looking at a pair of price target hikes in the defense sector —  General Dynamics Corporation (NYSE:GD) and Northrop Grumman Corporation (NYSE:NOC) — then move on to a downgrade in the neighboring air parts business: Spirit AeroSystems Holdings, Inc. (NYSE:SPR).

General Dynamics Corporation (NYSE:GD)

“General-ly” good news
First up, investment banker RBC Capital Markets is lifting price targets in the defense sector, raising its estimate for the value of General Dynamics Corporation (NYSE:GD) shares to $102, and for Northrop Grumman Corporation (NYSE:NOC) to $92. Both companies reported earnings this week. Let’s take them one at a time.

General Dynamics Corporation (NYSE:GD) reported $1.81 per share in profit yesterday, topping analyst estimates of $1.62 by 12%. Revenues also exceeded expectations, yet all these profits still leave General Dynamics Corporation (NYSE:GD) with a trailing-12-month profit of… nothing. Actually, less than nothing — $319 million in net losses. So why does RBC think this one is worth owning?

Perhaps it’s because no matter what the “net profits” numbers say, General Dynamics Corporation (NYSE:GD) really is making money. Real free cash flow at the company amounted to more than $2.1 billion over the past year, which gives the stock a price to free cash flow ratio of 14.3.

That being said, I still don’t think General D is making enough money to justify the buy rating RBC has on it, or the increased price target either. Fourteen times free cash flow isn’t an obviously expensive price, but with General Dynamics Corporation (NYSE:GD) currently pegged for about 6% annualized profits growth, and paying a dividend yield of less than 3%, it’s simply not growing fast enough, or paying out enough money, to justify its current valuation.

So… how about RBC’s other price-target hike? How do the numbers at Northrop Grumman Corporation (NYSE:NOC) look?

Here, we saw another “earnings beat” yesterday, with Northrop Grumman Corporation (NYSE:NOC) reporting $2.05 per share in profits, and exceeding expectations by 19%. Again, revenues came in stronger than expected, and with Northrop Grumman Corporation (NYSE:NOC) shares costing a bit less than 11 times GAAP profits (and the price to free cash flow ratio not much worse), this is a stock that looks quite a bit cheaper than General Dynamics. But is it cheap enough?

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