AAR meets some but not all of Benjamin Graham's requirements for a defensive stock. The Aerospace & Defense company does not offer a large enough margin of safety for cautious investors, but it does have many qualities that may interest more enterprising investors.
AAR Is Probably Overvalued
Graham devised the below equation to give investors a quick way of determining whether a stock is trading at a fair multiple of its earnings and its assets:
√(22.5 * 6 year average earnings per share (0.95) * 6 year average book value per share (32.31) = $38.35
After an impressive 48.0% performance over the 12 months, AAR is now trading well over its fair value because its Graham number is 56.2% above today's share price of $59.91. Even though the stock does not trade at an attractive multiple, it might still meet some of the other criteria for quality stocks that Graham listed in Chapter 14 of The Intelligent Investor.
Impressive Revenues, Consistent Profitability, and a Growing Dividend Imply Value
AAR’s average sales revenue over the last 6 years has been $2.93 Billion, so by Graham’s standards the stock has sufficient revenues to make it worthy of investment. When published in 1972, Graham’s threshold was $100 million in average sales, which would be the equivalent of around a half million dollars today.
Ben Graham believed that a margin of safety could be obtained by investing only in companies with consistently positive retained earnings. Retained earnings represent the cumulative net earnings or (deficit) left to equity holders after dividends have been paid out. AAR had positive retained earnings from 2010 to 2023 with an average of $666.84 Million over this period.
Ben Graham would also require a cumulative growth of Earnings Per Share of at least 30% over the last ten years.To determine AAR's EPS growth over time, we will average out its EPS for 2009, 2010, and 2011, which were $1.45, $1.16, and $1.73 respectively. This gives us an average of $1.45 for the period of 2009 to 2011. Next, we compare this value with the average EPS reported in 2021, 2022, and 2023, which were $1.00, $2.17, and $2.53, for an average of $1.90. Now we see that AAR's EPS growth was 31.03% during this period, which satisfies Ben Graham's requirement.
AAR’s Balance Sheet Meets Graham’s Criteria
It was also essential to Graham that the company’s current assets outweigh its current liabilities, and that its long term debt be inferior to the sum of its net current assets (current assets minus total liabilities). This is the aspect of the analysis that most companies fail, yet AAR passes comfortably, with an average current ratio of 2.9, and average debt to net current asset ratio of 0.2.
Conclusion
AAR offers a decent combination of value, growth, and profitability. These factors imply that the investment offers a decent margin of safety — especially if the shares are bought during a sell-off.
| 2017-07-12 | 2018-07-11 | 2019-07-18 | 2020-07-21 | 2021-07-21 | 2022-07-21 | |
|---|---|---|---|---|---|---|
| Revenue (MM) | $1,591 | $1,748 | $2,052 | $2,072 | $1,652 | $1,820 |
| Gross Margins | 17.0% | 17.0% | 16.0% | 13.0% | 17.0% | 17.0% |
| Operating Margins | 5% | 5% | 5% | 2% | 5% | 6% |
| Net Margins | 4.0% | 1.0% | 0.0% | 0.0% | 2.0% | 4.0% |
| Net Income (MM) | $56 | $16 | $8 | $4 | $36 | $79 |
| Net Interest Expense (MM) | -$5 | -$8 | -$8 | -$9 | -$5 | -$2 |
| Depreciation & Amort. (MM) | -$36 | -$40 | -$43 | -$44 | -$36 | -$33 |
| Earnings Per Share | $1.65 | $0.45 | $0.21 | $0.13 | $1.02 | $2.23 |
| EPS Growth | n/a | -72.73% | -53.33% | -38.1% | 684.62% | 118.63% |
| Diluted Shares (MM) | 34 | 35 | 35 | 35 | 35 | 35 |
| Free Cash Flow (MM) | $40 | $78 | $83 | -$13 | $116 | $85 |
| Capital Expenditures (MM) | -$19 | -$13 | -$16 | -$24 | -$11 | -$10 |
| Net Current Assets (MM) | $298 | $354 | $341 | $372 | $468 | $468 |
| Long Term Debt (MM) | $154 | $177 | $142 | $134 | $99 | $99 |
