Why Lockheed Martin and SAIC Stocks Popped, but GE Aerospace Dropped

Last week's news that Europe intends to boost defense spending is translating into gains for U.S. defense stocks Lockheed Martin (NYSE: LMT) and Science Applications International (NASDAQ: SAIC) this morning. As of 10:10 a.m. ET, Lockheed stock is up 3%, and SAIC is gaining 3.3%. GE Aerospace (NYSE: GE) on the other hand, which makes airplane engines for both military and civilian jets, is being left out in the cold, down 1.6%.

But why are two of these defense stocks popping while the third is dropping?

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Wall Street upgrades defense

It all starts with Europe. Last week as you may have heard, President Trump suspended shipments of some weapons, and sharing of some intelligence, with Ukraine as the president applied pressure, seeking to encourage that country to enter into peace talks with Russia.

Europe isn't on board with this strategy, however, and last Tuesday, European Commission President Ursula von der Leyen announced plans for an 800 billion euro ($841 billion) "REARM Europe" program. The funds will be used to bolster the militaries of Europe's 27 member countries, as well as to "massively step up their support to Ukraine."

Specifically, AP reports that the program would "allow member states to significantly increase their defense expenditures" without running afoul of EU rules against deficit spending. And Wall Street analysts are speculating that much of this money might go to purchasing weapons from U.S. defense contractors like Lockheed, SAIC, and GE.

On Wednesday, investment banker Citigroup opined that between "significant" recent declines in stock prices among defense stocks, and the potential for increased spending from Europe, "it's time to buy defense stocks." As the analyst said, defense stocks as a whole are priced for "negative 1% to positive 1% growth," reports The Fly. But this is "too punitive," according to Citi -- not just because Europe may be growing defense spending by $841 million, but because here in the U.S., Congress is seeking to add $300 billion more to the defense budget over the next 10 years.

This opinion is gaining traction on Wall Street. On Friday, for example, Wells Fargo argued defense stocks are starting to look "interesting," and raised its price target on Lockheed Martin stock in particular.

Are defense stocks cheap?

I'm not sure that I agree with that assessment.

On the one hand, Lockheed Martin's 21.2-times price-to-earnings valuation today is a lot cheaper than the average stock on the S&P 500 (SNPINDEX: ^GSPC), which costs closer to 28.8x earnings. Valued on sales, though, Lockheed Martin stock currently carries a price-to-sales ratio of 1.6, and is even more expensive with debt factored into the equation (i.e., its enterprise value-to-sales ratio is 1.8x). That's actually 43% more expensive than Lockheed Martin's average P/S valuation over the last 20 years.

I'm a bit more optimistic about SAIC, which at just 17.9 times earnings and 0.8 times trailing sales looks a lot cheaper than Lockheed stock. SAIC also boasts significantly greater (about 35%) free cash flow than it reports as net income, which isn't something you can say about Lockheed Martin. While the stock isn't quite cheap enough to entice me yet, I think it offers a more compelling valuation than Lockheed Martin.

Last but not least: GE Aerospace

GE Aerospace stock is trickier to value, because GE is more of a hybrid military-and-civilian business. If GE Aerospace were a pure defense business, I'd call its 5.5x P/S ratio very expensive. But because the company gets so much of its income from putting engines on civilian airliners, it doesn't fit completely nearly into the category of "big defense stock," so it probably deserves a richer valuation.

That said, even for a commercial company, 5.5x sales looks expensive to me, and GE stock costs nearly 32 times earnings as well. GE is even more expensive when valued on free cash flow, generating less than $0.60 in real cash profits for every $1 it reports in net income. With a projected long-term earnings growth rate of 18.5%, GE shares look richly priced to me.

Throw in a bit of Trump tariff risk as foreign customers potentially retaliate by raising tariffs in a trade war, and I agree with the investors on this one: GE stock is probably a sell.

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Citigroup is an advertising partner of Motley Fool Money. Wells Fargo is an advertising partner of Motley Fool Money. Rich Smith has no position in any of the stocks mentioned. The Motley Fool recommends GE Aerospace and Lockheed Martin. The Motley Fool has a disclosure policy.