Cramer vs. Cramer on Lockheed Martin – A “Buy” or “Sell! Sell! Sell!”?

A while back I posted an example of how money managers can be hazardous to your financial health. Now Jim Cramer, host of CNBC’s Mad Money, has provided us with a more recent example of how blindly following financial “experts” can prove costly (and confusing).

In this case it involves his recommendation(s) on Lockheed Martin (LMT: 70.57 +0.36%, yld: 3.58%), a dividend stock I highlighted positively recently (see “3 dividend stocks with high free cash flow“). Apparently, according to equity research firm Ockham Research, Cramer was also positive on the stock early last month, giving a caller on his show the following advice:

“Lockheed Martin is a buy. Now, a lot of people were disappointed by the last quarter, I say get a life. This is a company generating a gigantic amount of cash. It’s not expensive. It’s very well run. And as far as I’m concerned, this is the best bargain in the defense group. LMT, Lockheed Martin, pull the trigger right now.”

Not long afterward the company disappointed analysts by forecasting slightly lower-than-expected 2010 earnings – not great news, but nothing that suggested any significant change in the company’s underlying long-term fundamentals. In reaction, the stock sold off in the following days – from about $75 down to the upper $60s.

To a value investor, the lower stock price would appear to make it an even better bargain. To Cramer? Apparently not so much. According to Ockham Research, here’s what he told viewers just two weeks after recommending LMT as “the best bargain in the defense group”:

“The day after Lockheed disappointed, Northrop Grumman came out with a solid beat and a really nice outlook. The difference is stark. Lockheed seems to be losing programs left and right. Northrop Grumman won $10 billion of contracts in the third quarter…

In the past Northrop Grumman has been among the worst of the defense contractors, a company plagued by pension problems and crummy execution. Amazingly now it’s Lockheed Martin with the pension problem and Northrop Grumman indicated it made a last sizable pension contribution for a while…

Cheaper, faster growth, same yield. I think Northrop Grumman is the better stock and the better company.”

Okay, so it’s no secret that Cramer’s show is more about entertainment and trading performance than education and long-term investing. So, what’s the real story on Lockheed Martin’s valuation?

To find out, I did some valuation analysis using the latest earnings data and analyst estimates comparing LMT to several of its counterparts in the defense sector – Northrop Grumman (NOC: 57.82 +0.26%, yld: 3.12%), General Dynamics (GD: 59.67 +1.22%, yld: 2.71%), Boeing (BA: 64.62 +1.94%, yld: 2.65%) and Raytheon (RTN: 45.64 -0.04%, yld: 3.00%).

I used several different valuation methods and then averaged the results to arrive at an average “fair value” for each stock to compare to its current market price (11/4/09), and the results are shown below:

Clearly, based on these results, at the present time most of the defense sector appears undervalued, with Lockheed Martin being the best value. NOC and RTN are almost as cheap, but LMT appears to have a better record of dividend growth.

In addition, looking ahead, analysts’ expectations of future earnings growth are still the highest – at about 11% – for Lockheed Martin, compared to about 9.5% or lower for the others. And don’t forget about the company’s high free cash flow – it goes a long way toward ensuring a sustainable dividend payout.

Of course all this doesn’t mean LMT won’t trade lower in the weeks and months ahead. But it does suggest that the “cheaper” and “faster growth” choice remains LMT – not NOC.

Note: I’m currently short some March put options against LMT at a lower strike, meaning I’m willing to buy the stock (have it “put” to me) if it trades below the strike price between now and when the options expire.

Related posts:
3 dividend stocks with high free cash flow
Two companies about to raise their dividends
5 top CAPS-rated dividend stocks
General Dynamics: A defensive dividend play