Chasing Value: Defense and Oil -- Part 2

Benjamin Graham taught, and Warren Buffett learned to exploit, the idea of buying stocks at a discount to their intrinsic value, thus also allowing for a margin of safety. The book value of a company is one metric that hints at that because intrinsic value tries to assess what the company might be worth if it was dismantled and sold off. When assessing book value, one must recognize that this metric varies in its usefulness from industry to industry due to intangibles like the value of patents and other intellectual property, good will, differed maintenance appreciation and depreciation of assets.

Price-to-Book -- Defense (TTM)

• Northrop Grumman (NOC): 1.34
• Raytheon (RTN): 1.65
• General Dynamics (GD): 1.74
• Lockheed Martin (LMT): 6.72
• Boeing (BA): 10.96

Price-to-Book -- Oil (TTM)

• ConocoPhillips (COP): 1.25
• Royal Dutch Shell (RDS.A): 1.45
• Chevron (CVX): 1.6
• Exxon Mobil (XOM): 2.15
• PetroChina (PTR): N/A

Reviewing the P/B ratios does not help us to distinguish much. Among both sectors, only ConocoPhillips appears noteworthy on the low end. On the high end Lockheed Martin and Boeing are outside the range of acceptability.

Price-to-Cash-Flow -- Defense (TTM)

• Raytheon: 6.01
• Northrop Grumman: 7.69
• Boeing: 8.11
• General Dynamics: 8.23
• Lockheed Martin: 9.03

Price-to-Cash-Flow -- Oil (TTM)

• Chevron: 5.69
• ConocoPhillips: 6.23
• Royal Dutch Shell: 6.33
• PetroChina: 7.48
• Exxon Mobil: 8.52

All ten companies have P/CF levels below the market average, which is hovering around 10. This may be a reflection of the conservative nature of both the defense and oil sectors. The cutoff if one were grading on a curve looks to be in the sixes with Chevron, Raytheon, ConocoPhillips and Royal Dutch Shell all making the cut.

Dividend Yield -- Defense (TTM)

• Lockheed Martin: 3.77%
• Raytheon: 3.29%
• Northrop Grumman: 2.84%
• Boeing: 2.61%
• General Dynamics: 2.4%

Dividend Yield -- Oil (TTM)

• Royal Dutch Shell: 5.1%
• ConocoPhillips: 3.27%
• Chevron: 3.21%
• PetroChina: 3.02
• Exxon Mobil: 2.41%

Again we find healthy dividends all the way around. All ten stocks are paying yields above the market average. Clearly Shell is the standout, but this by itself would not lead one to make any conclusions about the overall strengths of the companies and I know of nothing that would threaten the yields of these stocks.

Looking at the data in total, it seems that the largest company with the strongest balance sheet, Exxon Mobil, demands the highest premium to purchase the stock. The same might be said about Boeing to some degree, using only the criteria herein, but one must go beyond the metrics and look at the stories associated with each company. Given our interest in buying in at a deep value if we can, and considering the purpose of this particular exercise, I am going to cut three more stocks.

I am removing Exxon simply because the other oil companies give you more value and provide similar safety. I am removing Boeing because so much of its commercial business and production appears to be behind schedule and therefore overbudget as well. In addition this story is about what might offer a safe haven or counterbalance to market forces if war or terrorism were to occur, and Boeing being tied to commercial aviation might be negatively affected even if it has a significant defense aspect. Finally I am removing PetroChina because the stock information is harder to come by and its association with China; southeast Asia might be in the eye of the storm, therefore not offering the benefits we seek.

The series will continue until we find the stocks worthy of inclusion in my list of 2011 stock picks.

Sheldon Liber is registered architect and the CEO of Chasing Value ™ Asset Management, Inc., a small private investment company. He writes the columns Chasing Value™ and Serious Money, and is on twitter: ChasingValue Disclosure: He owns shares and/or options in PTR, RDS.A, and RTN.