Net income, or earnings, is one of the relatively easier metrics to manipulate. A recent study shows that about one in five companies manage their earnings to misrepresent economic performance. They do this through legal exploitation of accounting standards. This is usually done to meet investors’ expectations of the companies’ guidelines or to meet short-term targets for incentives.
In light of this information, it’s important for us to analyze how Lockheed Martin (LMT) managed to increase its earnings despite a fall in its revenues.
We also need to analyze when LMT and other defense players—like The Boeing Company (BA), Raytheon Company (RTN), and General Dynamics (GD)—are faced with difficult industry conditions. If an increase in earnings is due to a one-time activity or change in accounting policy, the increase will be difficult to sustain.
Most of the companies are part of the Dow Jones U.S. Select Aerospace Index (ITA).
Lockheed Martin’s earnings per share (or EPS) increased for two reasons:
- Benefits from the cost reduction activities that the company has been doing to combat the fall in defense spends
- Reduced share activity due to the company’s share repurchase strategy
One cost reduction activity includes transferring employees from a defined benefit plan to a defined contribution plan. This reduced the company’s pension costs. The company has managed to raise its earnings before interest and tax (or EBIT) margins from 10.43% in 3Q13 to the 11.47% this year.
In the next part of the series, we’ll discuss how LMT’s stock reacted to the rise in earnings even though sales missed.