The next selection for the Inflation-Protected Income Growth Portfolio is defense contracting giant Raytheon Company (NYSE:RTN). Although it’s up against a potential loss of revenue due to the anticipated defense spending sequestrations, the reality is that the cuts, if they happen, will really just slow the rate of spending growth.
Nevertheless, the threat of defense spending cuts reduced the company’s forecast, thus knocking down its stock in recent weeks. That drop in stock price brought the shares down into a range where the iPIG portfolio is willing to buy.
Why it’s worth owning in the iPIG Portfolio
To earn a spot in the portfolio, a company has to pass a series of tests related to its dividends, its balance sheet and valuation, and how it fits from a portfolio diversification perspective.
Dividends:
1). Payment: The company’s dividend currently sits at $2 a share, a yield of about 3.7% based on Friday’s closing price.
2). Growth history: The company has raised its dividend annually since 2005, resuming a streak of increases that ended in the mid-1990s.
3). Reason to believe the growth can continue: With a payout ratio of 35%, Raytheon retains nearly two-thirds of its earnings to invest for future growth. That fairly low payout ratio also gives it the flexibility to maintain its payment during the potential sequestration and/or if that anticipated longer-term growth doesn’t materialize as quickly as hoped.
Balance sheet and valuation:
Balance sheet: A debt-to-equity ratio of around 0.6 indicates that the company does use debt, but it hasn’t overleveraged itself to the point where a near-term financial hiccup would derail it.
Valuation: By a discounted cash flow analysis that takes into account Raytheon’s recently lowered guidance, it looks to be worth around $18.8 billion. That makes its market cap of $17.6 billion seem reasonable.
Diversification fit:
The previous picks for the portfolio included:
- An industrial conglomerate
- A generic-pharmaceutical powerhouse
- A provider of staple foods
- An auto parts distributor
- A safety equipment provider
- A high-tech (software) titan
- A toy maker
- An electric utility
- A shipping company
- A pipeline giant (though this one might actually get away)
- A drugstore
- A semiconductor superstar
- A two-for-one railroad special
- A fast-food juggernaut
- A medical device maker
- A supplemental insurance writer
- An air chemicals business
Fellow iPIG portfolio selection United Technologies Corporation (NYSE:UTX) also has a significant military contracting business, which makes Raytheon a less-than-ideal pick from a diversification perspective. Still, it’s more of a pure-play defense business than the more conglomerated United Technologies, and Raytheon’s recent stock weakness makes it attractive enough from a valuation perspective to consider buying. It may not be perfect diversification, but it’s all part of the balancing act needed to manage across risks in investing.
Why pick it over its peers?
Still, as Raytheon is only one of several defense contractors out there, it raises the question: Why select this company instead of one of the others? The table below shows some key measure comparisons that led to its selection:
| Company | Yield | Payout Ratio | 5-Year Estimated Growth Rate | Debt-to-Equity Ratio | Price-to-Earnings Ratio |
|---|---|---|---|---|---|
| Raytheon | 3.7% | 35% | 5.7% | 0.6 | 9.7 |
| Lockheed Martin (NYSE:LMT) | 5.2% | 50% | 7.9% | 161.7 | 10.5 |
| Rockwell Collins (NYSE:COL) | 2% | 34% | 9.7% | 1.1 | 13.9 |
| Northrop Grumman (NYSE:NOC) | 3.4% | 28% | (1.7%) | 0.4 | 8.4 |
Data from Yahoo! Finance, as of Feb. 18, 2013.
