Valuing Defence Primes (FCF Yield)

FCF Yield Cross-Checks What P/E Misses

Defence primes can screen one way on trailing P/E and another way on FCF yield, because contract accounting can separate reported earnings from distributable cash. FCF yield (FCF ÷ market cap) catches the gap. Long-cycle percentage-of-completion revenue, pension and FAS/CAS timing (the gap between GAAP and government-contract pension accounting), and working-capital swings all mean EPS alone is an unreliable signal of what a prime can distribute.

Compute yield from filed FCF and valuation-date market cap, both taken at the same date.

Computing the FCF Yield Screen

FCF yield = FY2025 FCF ÷ market cap.

Take a hypothetical prime with $5B of filed FCF and a $100B market cap: $5B ÷ $100B = 5.0%. The inputs are the hard part. Lockheed Martin’s FCF conversion of 138% shows why: FY2025 net income of $5.0B converted to $6.9B of FCF. That conversion figure is why the two screens can read differently for the same company; a P/E built only on net income misses the extra cash the business generated that year.

Screening bands for mature US primes, a working convention we state rather than source because no filed sector FCF-yield benchmark exists:

The bands describe where a set of six filers landed in one year. Conversion, backlog cover and programme concentration each move the number for reasons that have nothing to do with mispricing. So the rest of this guide cross-checks the yield.

Conversion Explains Why Yield and P/E Diverge

Conversion decides how much weight to put on FCF yield versus P/E for a given prime. L3Harris’s FY2025 GAAP net income was $1.6B against $2.7B of FCF, a conversion ratio of 170%. A trailing P/E is a pure earnings multiple; an FCF yield is a pure cash multiple. At that level of conversion the two disagree, because GAAP net income understated distributable cash that year.

Lockheed Martin shows the same mechanism at a smaller scale. Its 138% conversion sits well short of L3Harris’s, and the further conversion runs above 100%, the further an earnings multiple and a cash yield drift apart. The FCF conversion guide has the full peer set on conversion.

Which screen to weight more heavily depends on whether the conversion ratio looks repeatable, not on which screen currently reads the more favourable number.

Sector Multiples as Context Only

Damodaran Aerospace/Defense sector aggregates (Jan 2026):

50.6% of trailing firms in the Damodaran sample are loss-makers, which inflates the sector forward P/E. Prime trailing P/Es (~19-36x) run from well below the 35.27x profitable-firm aggregate to just above it. No prime is measured against it.

FCF yield has no published sector benchmark in primary sources. The 3-5% band above is anchored on the six filed peers.

BAE: The FX Adjustment

BAE reports in GBP. Any USD cross-peer screen must state the FX rate and date:

• Market cap: ~£58.5B (~$78.3B at GBP/USD 1.3387, 10 June 2026)
• FY2025 FCF: £2,158M (group alternative performance measure, BAE’s own non-IFRS basis)

Restate both cap and FCF at the same FX rate and date before comparing BAE to a US peer. Converted together, the yield comes out the same in either currency; the error comes from dividing a GBP FCF by a USD cap, or from converting the two at different dates. The BAE profile covers the GBP/IFRS reporting differences.

Worked Comparison: LMT vs RTX

Both are large-cap, US-listed, defence-exposed names, but their FCF comes from different revenue mixes, and that changes what a yield on each would be measuring:

RTX generates more absolute FCF, but only about half its revenue is defence; the rest runs through the commercial aerospace businesses at Pratt & Whitney and Collins Aerospace. A yield on RTX therefore blends a defence cash stream with a commercial one that follows a different cycle. LMT’s FCF comes almost entirely from government revenue. The conversion ratios explain the gap between each company’s own earnings and cash. They say nothing about how much growth a market cap assumes, and neither does the FCF yield.

Programme Concentration and the Multiple

FCF yield does not capture binary programme risk. LMT’s F-35 programme was 27% of FY2025 consolidated sales, above our >25% concentration screen; General Dynamics’ nuclear submarine programme was 24%, just below it. A high FCF yield on a concentrated platform prime carries a different risk profile from the same yield on a diversified systems integrator, because a single contract decision can move a much larger share of one company’s revenue than the other’s.

Cross-check the yield screen with backlog momentum and budget exposure before treating it as decisive on its own. RTX’s FY2025 book-to-bill was 1.56x on a $268B backlog; Lockheed Martin’s management cited roughly 1.2x on the earnings call, outside the filed exhibit. Book-to-bill shows whether the backlog funding future cash flow is growing or shrinking; programme concentration shows how much of that backlog rests on one contract decision. Neither shows up in the FCF yield itself.

Building the Screen

1. Pull FY2025 FCF from the earnings exhibit (company-defined, unadjusted).
2. Use valuation-date market cap (shares × price); restate BAE at the stated FX rate.
3. Compute FCF yield and trailing P/E side by side.
4. Check FCF conversion against the house bands: above 90% strong, 70-90% normal, below 70% investigate before treating the yield as reliable.
5. Compare the yield to the screening bands (<3% / 3-5% / >5%).

The Lockheed Martin profile is the platform-concentration case, filed at 138% FCF conversion. L3Harris is the highest-conversion case in the set, at 170% on a GAAP basis. RTX is the dual defence-and-commercial comparator.