Unarguably, Boeing Co (NYSE:BA) has had a great year.
What has been driving the huge rally in BA stock? General enthusiasm in the airline and defense markets.
An explosion in the experience-first mantra among consumers is having a positive effect on airline traffic globally. Moreover, China’s massive urbanization boom means that more people than ever are starting to fly in China. Today, one of out every four Boeing planes produced is being shipped to China.
This growth has longevity. More than 80% of people in the world have never taken a flight, implying that there is a tremendous growth opportunity ahead for Boeing on the airline front.
Meanwhile, rising international tensions (see North Korea) are causing many countries to up their defense and military spends. For the first time since 2010, global sales of arms and military services grew in 2016. With tensions only rising, we are likely looking at a streak of growth years ahead.
Lockheed Martin Corporation (NYSE:LMT) is the largest arms producer in the world, and naturally the biggest winner here. But Boeing is number 2, and will share in the rewards of renewed growth.
All this growth means a ton more cash flow for Boeing, which management is giving back to shareholders. BA recently hiked its dividend by 20%, while replacing the existing share repurchase program with a new $18 billion authorization.
Plus, there is the whole tax reform angle.
Put all of this together, and it’s easy to see why BA stock has nearly doubled this year. It’s a narrative with big growth that is here to stay, healthy dividend hikes, and big buybacks.
But can BA stock repeat on its success in 2018?
I think that will be difficult to do. Here’s why.
Two Concerns With BA Stock in 2018
Boeing is a great company with strengthening growth prospects. I have no problem with the company. But BA stock looks risky here.
First, there is the valuation aspect.
Boeing’s earnings estimates for the next several years have trended up in a healthy manner over the past 12 months, but even with those upped estimates, earnings are still only expected to grow 13% per year over the next two years.
But BA stock trades at 29.3x this year’s earnings estimate. That is a 125% premium to growth prospects, which seems unnecessarily large. The S&P 500 is trading at a 95% premium to growth prospects (20.5x this year’s earnings for 10.5% earnings growth).
BA stock is also trading at a huge premium to its historical valuation. The price/earnings multiple is currently 35% above its five-year average, price/cash flow is 27% above its five-year average, and the EV/EBITDA multiple is 43% above its five-year average.
Yes, those multiples should be bigger because growth prospects are stronger now than they were over the past five years, but not that much bigger. We are talking 30%-plus premiums in valuation here for growth that isn’t that much bigger.
Second, there is the aspect that stocks don’t run up in straight lines forever.
Over the past decade, BA stock has staged two big rallies like this before. Both rallies lasted about a year, saw BA stock price double, and then led to a prolonged period of BA stock trading sideways.
The first one was from February 2009 to March 2010, when BA stock more than doubled from $30 to $70. But then it fell flat for the next several years.
The second big rally was from January 2013 to December 2013, when BA stock doubled from $70 to $140. Again, BA stock traded sideways for several years after that rally.
We are currently in a similar rally that has lasted a little over a year and has seen BA stock price double. Given the aforementioned valuation concerns, I think it’s likely this rally ends soon and BA stock trades sideways for most of 2018.
Bottom Line on BA Stock
Great company, overbought stock.
I think BA stock will have a tough time replicating its 2017 success in 2018.
As of this writing, Luke Lango was long FB, AMZN, NFLX, and GOOG.