Better Buy: Raytheon Company vs. Northrop Grumman

Markets Motley Fool

Defense stocks have come back into the public eye lately, with the Trump administration looking to increase the defense budget to support the U.S. military. Both Raytheon (NYSE: RTN) and Northrop Grumman (NYSE: NOC) will be interested in getting new business from a ramp-up in military spending, and both are likely to get their fair share of any budget increase. Investors want to know whether one of the companies is likely to have an edge over the other from the standpoint of better return on their shares. Below, you'll see Raytheon and Northrop Grumman compared on various metrics designed to show you which one looks like the right pick right now.

Continue Reading Below

Valuation and stock performance

Both Raytheon and Northrop Grumman have seen their shares rise in response to the more favorable outlook for defense spending. Since July 2016, Raytheon has delivered a 25% return to its shareholders. Northrop lags just behind with a 20% rise in its share price over the same period.

Looking at valuations, the slightly weaker performance for Northrop Grumman translates into a slightly more attractive share price as measured against its earnings prospects. Based on what it has brought in over the past 12 months, Northrop trades at 21 times trailing earnings, compared to an earnings multiple of 22 for Raytheon. The story stays largely the same when you look at near-term future projections for the bottom line. Northrop's forward multiple weighs in at 19, compared to Raytheon's 20. The two stocks are close enough in terms of valuation and recent performance to be nearly indistinguishable.

Dividends

When you look at dividends, the two defense contractors also have a lot of similarities. Raytheon's current dividend yield of 1.9% is a bit higher than Northrop's 1.5% yield. But both companies have plenty of room to grow their payouts if they so choose, with payout ratios of less than 30% of earnings.

Continue Reading Below

Raytheon and Northrop Grumman have also committed to paying growing dividends over time. Raytheon has boosted its annual payout for 13 straight years, including a solid 9% increase earlier this spring. Northrop sports a slightly longer streak of 14 years of annual dividend increases, and its 11% hike in June brought its quarterly payout to an even $1 per share. Raytheon might have a slight edge now, but Northrop looks like it's aiming to close any gap in the future.

Growth and risk profile

The defense business has been improving lately, and it's been up to each defense contractor to take maximum advantage of the better conditions they face. Raytheon's first-quarter results showed considerable internal discipline in making the most of revenue, as the company's enjoyed a one-fifth rise in earnings per share even though sales climbed by only 3%. Success in the space and airborne systems segment helped to offset declines in intelligence, information, and related services. Since then, sales of the company's Patriot missile defense system have benefited from interest overseas, and Raytheon has benefited from a near-sweep of a $1 billion plan to sell military assets to Taiwan. Performance in its cybersecurity division hasn't lived up to what Raytheon has seen on the military hardware side of the business, but in the current environment, that hasn't been a huge drag on overall results.

For Northrop Grumman, recent results have also been strong. The aerospace systems division was instrumental in driving overall growth, posting a 13% rise in sales. Northrop's mission systems and technology services segments saw more measured performance, but net profit was up 15% from the year-ago period. Northrop is far more exposed to the U.S. market than Raytheon or most other major defense contracts, and that arguably puts Northrop in a better position to benefit from rising U.S. military spending. The key to the company's success will be how well it can capitalize on the budding drone industry, where there are plenty of military and commercial applications that could drive sales higher in the years to come.

It's hard to choose between Raytheon and Northrop Grumman, because they're so close together on key metrics. Your best bet is to keep an eye on the two defense contractors when they announce their latest results later this week and to see which one appears to be carrying more forward momentum into the second half of 2017 and beyond.

10 stocks we like better than Raytheon
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*

David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Raytheon wasn't one of them! That's right -- they think these 10 stocks are even better buys.

Click here to learn about these picks!

*Stock Advisor returns as of July 6, 2017

Dan Caplinger has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.