Streetwise

Lauren Rudd

Sunday, April 3, 2011

Look For Companies With A Symbiotic Relationship

Before you decide to become a card carrying member of the Chicken Little league, as a result of listening to the soothsayers of doom predict economic Armageddon as a consequence of the continuing atrocities in the Middle East, the debacle resulting from Japan’s somewhat furtive attempts to bring its damaged nuclear reactors under control, a falling dollar, rising oil and gas prices, and of course the growing deficit and national debt, consider that a funny thing happens on the way to Wall Street.

Stocks over time outperform other investments, period. The reason is that businesses retain earnings, which are reinvested to generate additional earnings and higher dividends. Driving it all is the basic theory of compounded return.

Therefore, now is time to step up to the bar and take responsibility for your financial future. Yes, Wall Street has been volatile of late and yes, many of the major players have shown little inclination to do anything but line their own pockets.

Not to ruin your day but the financial markets have always been driven by greed, as are most markets. Furthermore, the wealthiest are often the greediest. This is no sudden epiphany; it has been so throughout history. Technology and time have merely changed the way and speed with which we do business, not the seemingly insatiable desire for ever increasing amounts of wealth.

However, the Street’s antics should never be an impediment to your building a portfolio. So where do you start? Well you could pour yourself a glass of suds as you wait for the gods of chance to look favorably upon your lottery ticket.

Or you can begin by looking for companies that show a symbiotic relationship with the affairs of state, preferably on a global basis. A good example might be Raytheon (RTN), despite a somewhat less than ebullient share price performance over the past year.

When I wrote about the company a year ago, my earnings estimate for 2010 was $5.00 per share and $5.50 per share in 2011, with a 12-month target share price of $67. Earnings came in at $4.79 per share and the shares recently closed at $50.70. So is Raytheon still a viable investment candidate? I believe the answer is yes. Let me explain.

Let’s look at two key metrics. The first is return on invested capital (ROIC), which measures how well a company utilizes its invested capital. Breaking ROIC into two parts, the first part, or numerator, is calculated as after-tax operating income.

Operating income, or operating revenue minus operating expense, is an excellent way of judging a business's results by removing non-recurring items and interest costs. Subtract out the part that would be paid to Uncle Sam and you have net operating profit after taxes (NOPAT).

The second part, or the denominator, is invested capital. This is most often calculated as total assets less cash and non-interest bearing current liabilities. Divide NOPAT by invested capital and what you have is the after-tax return on invested capital. As a side note, this is a key metric for Warren Buffett.

For Raytheon, its ROIC was 14.6 percent in 2010 and is projected in the company’s guidance to be between 13.4 and 13.9 percent in 2011, a small decline from 2010 but still a respectable number.

Furthermore, Raytheon ended 2010 with a strong balance sheet that had $3.6 billion in cash and a backlog of $34.6 billion. Sales in 2011 are projected at $25.5 to 26.3 billion with an earnings guidance of $4.83 to $4.98 per share.

A second key metric is intrinsic value. Using a discounted earnings model, Raytheon’s intrinsic value is $96 per share. The more conservative discounted free cash flow to the firm model yields an intrinsic value of $150 per share Remember, the recent share price is $50.70.