Here’s why its price suggests it’s overvalued.
When it comes to investing in the defense sector, Northrop Grumman (NOC) often catches the eye of investors seeking stability and growth in a volatile market. As a leading aerospace and defense contractor, NOC plays a critical role in national security, with a portfolio spanning advanced aircraft, missile systems, and space technologies. But with its stock price hovering at $497.70 as of June 20, 2025, is Northrop Grumman a bargain or overvalued? To answer this, I’ve conducted an in-depth analysis using two valuation methods inspired by Warren Buffett and a lesser-known but powerful approach, the McGrew Valuation Method. Using five years of financial data from Northrop Grumman’s quarterly reports, I’ll calculate its intrinsic value, apply a margin of safety, and assess whether it’s a buy, hold, or sell. Let’s dive in.
Understanding the Valuation Methods
The Buffett Valuation Method, rooted in discounted cash flow (DCF) principles, estimates a company’s intrinsic value by projecting its free cash flow (FCF) over 10 years and calculating a terminal value. For Northrop Grumman, I used a 5% growth rate for stable firms (since its 5-year FCF CAGR was negative at -11.36%) and an 8% discount rate (4% Treasury yield plus a 4% risk premium). The terminal value assumes a 2.5% perpetual growth rate, reflecting long-term economic growth.
The McGrew Valuation Method is similar but adjusts for growth stocks. For companies with a 5-year FCF CAGR above 10%, it applies a declining growth rate from the historical CAGR to 10% by Year 7. However, since NOC’s FCF CAGR is negative, it mirrors the Buffett method for non-growth stocks, using the same 5% growth rate and 2.5% perpetual growth.
Data Inputs: The Foundation of the Analysis
Using Northrop Grumman’s financial data from 2020 to 2024, I gathered the following:
- Free Cash Flow (FCF):
- 2024 (TTM): $1,776 million
- 2023: $2,100 million
- 2022: $1,466 million
- 2021: $2,152 million
- 2020: $2,885 million
- Shares Outstanding: 144,071,022 (as of 03/31/2025)
- 5-Year FCF CAGR: Calculated as ($1,776M / $2,885M)^(1/4) – 1 ≈ -11.36%. Due to the negative CAGR, I assumed a 5% growth rate for projections, as per the valuation guidelines.
- Last Closing Price: $497.70 (assumed for June 20, 2025, the last trading day before June 22, 2025).
Buffett Valuation: Step-by-Step
- Project FCF for 10 Years: Starting with the 2024 TTM FCF of $1,776 million, I applied a 5% annual growth rate. For example, Year 1 FCF is $1,865 million, Year 2 is $1,958 million, up to Year 10 at $2,893 million.
- Terminal Value: In Year 10, the terminal value is calculated as $2,893M × (1 + 0.025) ÷ (0.08 – 0.025) ≈ $53,915 million.
- Discount to Present Value: Using an 8% discount rate, I discounted each year’s FCF and the terminal value. The present values sum to $38,224 million.
- Intrinsic Value per Share: Dividing by 144,071,022 shares yields $265.27 per share.
- Price with 25% Margin of Safety: $265.27 × 0.75 ≈ $198.95.
McGrew Valuation: A Mirror Image
Since NOC’s 5-year FCF CAGR is negative, the McGrew method adopts the same parameters as the Buffett method for non-growth stocks. Thus, the intrinsic value per share is also $265.27, with a 25% margin of safety price of $198.95.
Valuation Status: Is NOC a Buy?
To determine NOC’s valuation status, I compared the closing price of $497.70 to the intrinsic value of $265.27:
- Percentage Difference: ($497.70 – $265.27) ÷ $265.27 × 100 ≈ 87.62%
- Status: Since the closing price is more than 36% above the intrinsic value, NOC is Overvalued under both methods.
Valuation Table
| Stock Ticker | Valuation Method | Intrinsic Value per Share | Price with 25% Margin of Safety | Last Closing Price | Valuation Status |
|---|---|---|---|---|---|
| NOC | Buffett Valuation | $265.27 | $198.95 | $497.70 | Overvalued |
| NOC | McGrew Valuation | $265.27 | $198.95 | $497.70 | Overvalued |
Financial Health: ROE and RoNTE Insights
To provide additional context, I calculated NOC’s TTM Return on Equity (ROE) and Return on Net Tangible Equity (RoNTE):
- ROE: Using TTM Net Income of $3,711 million and average Common Stock Equity of $14,830.75 million, ROE = ($3,711M ÷ $14,830.75M) × 100 ≈ 25.02%. This strong ROE reflects efficient use of shareholder equity.
- RoNTE: With average Net Tangible Assets of -$2,925.5 million (negative due to significant intangibles like goodwill), RoNTE = ($3,711M ÷ -$2,925.5M) × 100 ≈ -126.85%. The negative RoNTE is typical for defense firms with large intangible assets, indicating that earnings are driven by intangible value rather than tangible assets.
What Does This Mean for Investors?
At $497.70, Northrop Grumman’s stock price significantly exceeds its intrinsic value of $265.27, suggesting it’s overvalued by both Buffett and McGrew methods. The 25% margin of safety price of $198.95 is far below the current price, indicating that investors would need a substantial price drop to consider NOC a buy. A Screaming Buy would require the price to fall below $198.95 (25% below intrinsic value), while a Buy would be between $246.70 and $198.95 (7% to 25% below). Currently, the stock is in Overvalued territory, suggesting caution.
However, NOC’s strong ROE of 25.02% highlights its ability to generate profits from equity, and its role in the defense sector ensures stable demand due to government contracts. The negative FCF CAGR (-11.36%) over the past five years raises concerns about cash flow consistency, possibly due to large capital expenditures or contract timing in the defense industry. Investors should monitor future FCF trends to assess whether growth stabilizes.
Limitations and Considerations
- Data Source: All calculations used provided financial data from NOC’s quarterly reports, ensuring accuracy but lacking external validation (e.g., Yahoo Finance).
- Negative FCF CAGR: The -11.36% CAGR led to a conservative 5% growth assumption, which may underestimate NOC’s future potential if contract wins improve cash flows.
- Intangibles: The negative Net Tangible Assets skew RoNTE, making it less useful for valuation but typical for defense firms.
- Market Dynamics: Defense stocks like NOC can be influenced by geopolitical events and government budgets, which may not be fully captured in DCF models.
Conclusion: Hold Off for Now
Northrop Grumman’s robust ROE and stable revenue from defense contracts make it an attractive long-term investment, but its current price of $497.70 suggests it’s overvalued. Investors seeking value should wait for a price closer to $198.95–$246.70 for a margin of safety. Those already holding NOC might consider it a Hold, but new investors should exercise caution unless the price corrects significantly. Keep an eye on NOC’s FCF growth and defense sector trends for future opportunities.
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