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ModernGraham Valuation: General Dynamics Corp. (GD)

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Company Profile (obtained from Google Finance): General Dynamics Corporation is an aerospace and defense company that offers a portfolio of products and services in business aviation; combat vehicles, weapons systems and munitions; military and commercial shipbuilding, and communications and information technology. The Company operates through four business groups: Aerospace, Combat Systems, Marine Systems and Information Systems and Technology. In December 2011, it acquired Force Protection, Inc. In February 2012, the Company acquired the Enterprise Jet Center FBO at Hobby Airport in Houston, Texas. In June 8, 2012, the Company acquired IPW Holdings, Inc. In August 2012, it acquired Ship Repair and Coatings Division of Earl Industries. In August 2012, the Company acquired the defense operations of Gayston Corporation. In August 2012, the Company acquired Fidelis Security Systems, Inc. In September 2012, it acquired Open Kernel Labs, Inc. In December 2012, the Company acquired Applied Physical Sciences Corp.

Defensive and Enterprising Investor Tests (What is the significance of these tests, and what is PEmg ratio?):

Defensive Investor – must pass at least 6 of the following 7 tests: Score = 4/7

  1. Adequate Size of Enterprise – market capitalization of at least $2 billion – PASS
  2. Sufficiently Strong Financial Condition – current ratio greater than 2 – FAIL
  3. Earnings Stability – positive earnings per share for at least 10 straight years – FAIL
  4. Dividend Record – has paid a dividend for at least 10 straight years – PASS
  5. Earnings Growth – earnings per share has increased by at least 1/3 over the last 10 years using 3 year averages at beginning and end of period – FAIL
  6. Moderate PEmg ratio – PEmg is less than 20 – PASS
  7. Moderate Price to Assets – PB ratio is less than 2.5 or PB x PEmg is less than 50 – PASS

Enterprising Investor – must pass at least 4 of the following 5 tests or be suitable for a defensive investor: Score = 2/5

  1. Sufficiently Strong Financial Condition, Part 1 – current ratio greater than 1.5 – FAIL
  2. Sufficiently Strong Financial Condition, Part 2 – Debt to Net Current Assets ratio less than 1.1 – PASS
  3. Earnings Stability – positive earnings per share for at least 5 years – FAIL
  4. Dividend Record – currently pays a dividend – PASS
  5. Earnings growth – EPSmg greater than 5 years ago – FAIL

Valuation Summary (Explanation of the ModernGraham Valuation Model)

Key Data:

MG Value $21
MG Opinion Overvalued
Value Based on 3% Growth $69
Value Based on 0% Growth $41
Market Implied Growth Rate 5.41%
Net Current Asset Value (NCAV) -$16.32
PEmg 19.32
Current Ratio 1.42
PB Ratio 2.58

Balance Sheet – 9/30/2013 

Current Assets $17,118,000,000
Current Liabilities $12,065,000,000
Total Debt $3,908,000,000
Total Assets $35,471,000,000
Intangible Assets $13,256,000,000
Total Liabilities $22,866,000,000
Outstanding Shares 352,200,000

Earnings Per Share – Diluted

2013 (estimate) $6.95
2012 -$0.94
2011 $6.94
2010 $6.82
2009 $6.20
2008 $6.22
2007 $5.10
2006 $4.20
2005 $3.63
2004 $2.99
2003 $2.50
2002 $2.56

Earnings Per Share – Modern Graham (Calculating EPSmg)

2013 (estimate) $4.78
2012 $4.14
2011 $6.54
2010 $6.13
2009 $5.55
2008 $4.96

Conclusion:

General Dynamics Corp is a company that is damaged considerably by an extremely poor 2012 showing.  That year, the company’s EPS totaled a negative $0.94, a result that has had a clear effect on the company’s EPSmg (normalized earnings) as well as its performance in the tests for the Defensive Investor and Enterprising Investor.  The company fails to pass the requirements of either investor type because of the poor 2012 showing.  And let’s be clear here – even if the negative earnings of 2012 are related to a one-time charge or some exceptionally abnormal event, the fact remains that the company lost money that year, a result that is unacceptable to Intelligent Investors.  After all, that violates the first key rule of our 7 Key Tips to Value Investing.

From purely a valuation perspective, the negative earnings of 2012 also has a profound effect.  By lowering the EPSmg for 2012 and 2013, it has significantly lowered the level of earnings growth we may be able to anticipate.  Therefore, the market seems to overvalue the company at this time by anticipating a growth rate of over 5% when the historical performance does not support it.  Any potential investor in General Dynamics would be very wise to consult with a registered broker and do considerably further research into the company before entering into any investment position.

What do you think?  Is General Dynamics Corp overvalued?  Is the company not suitable for either Defensive Investors or Enterprising Investors?  Leave a comment or mention @ModernGraham on Twitter to discuss.

If you like our valuations, why not check out ModernGraham Stocks & Screens?  It’s a great way to review the valuations while screening for things like low PE ratio, undervalued companies, etc.!

Disclaimer:  The author did not hold a position in General Dynamics Corp at the time of publication and had no intention of entering into a position within the next 72 hours.

Photo Credit:  Andrew Magill

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