Lockheed Martin has been treading water for the past six months, recording a small loss of 0.7% while holding steady at $468.11. The stock also fell short of the S&P 500’s 19.5% gain during that period.
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Why Do We Think Lockheed Martin Will Underperform?
We're cautious about Lockheed Martin. Here are three reasons we avoid LMT and a stock we'd rather own.
1. Weak Backlog Growth Points to Soft Demand
Investors interested in Defense Contractors companies should track backlog in addition to reported revenue. This metric shows the value of outstanding orders that have not yet been executed or delivered, giving visibility into Lockheed Martin’s future revenue streams.
Lockheed Martin’s backlog came in at $179.1 billion in the latest quarter, and over the last two years, its year-on-year growth averaged 6.8%. This performance slightly lagged the sector and suggests that increasing competition is causing challenges in winning new orders. 
2. EPS Trending Down
Analyzing the long-term change in earnings per share (EPS) shows whether a company's incremental sales were profitable – for example, revenue could be inflated through excessive spending on advertising and promotions.
Sadly for Lockheed Martin, its EPS declined by 5.2% annually over the last five years while its revenue grew by 2.7%. This tells us the company became less profitable on a per-share basis as it expanded.
3. New Investments Fail to Bear Fruit as ROIC Declines
ROIC, or return on invested capital, is a metric showing how much operating profit a company generates relative to the money it has raised (debt and equity).
We like to invest in businesses with high returns, but the trend in a company’s ROIC is what often surprises the market and moves the stock price. Over the last few years, Lockheed Martin’s ROIC has unfortunately decreased significantly. We like what management has done in the past, but its declining returns are perhaps a symptom of fewer profitable growth opportunities.
Final Judgment
Lockheed Martin doesn’t pass our quality test. With its shares underperforming the market lately, the stock trades at 17× forward P/E (or $468.11 per share). While this valuation is fair, the upside isn’t great compared to the potential downside. There are better stocks to buy right now. We’d recommend looking at one of our top digital advertising picks.
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