Valuing Defence Primes (FCF Yield)
How to compute FCF yield for defence primes and cross-check it against P/E, using FY2025 filed figures, the BAE FX adjustment, and FCF conversion.
Educational analysis for professional use. This guide is not investment advice or a recommendation to buy or sell any security, and it is not personalised.
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) is the practitioner check that 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 actually distribute.
Compute yield from filed FCF and valuation-date market cap. The worked example below uses FY2025 FCF and a market cap as of 10 June 2026.
Computing the FCF Yield Screen
FCF yield = FY2025 FCF ÷ market cap.
Lockheed Martin’s FY2025 FCF was $6.9B. Its market cap on 10 June 2026 was ~$122B. $6.9B ÷ ~$122B ≈ 5.7%. Its trailing P/E on the same date was ~24x, on FCF conversion of 138%: FY2025 net income of $5.0B converted to $6.9B of FCF. That conversion figure is why the two screens read differently; 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:
| FCF yield | Where filers clustered (FY2025) |
|---|---|
| <3% | Below the filed range |
| 3-5% | Where five of the six filers landed |
| >5% | Above the filed range |
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, which is why the rest of this guide cross-checks the yield rather than reading it alone.
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%. Its trailing P/E of ~36x is a pure earnings multiple; its ~4.8% FCF yield is a pure cash multiple. The two disagree because GAAP net income understated distributable cash that year.
Lockheed Martin shows the same mechanism at a smaller scale, using the FCF, market cap and yield already worked through above. Its 138% conversion sits well short of L3Harris’s, and that gap in conversion is why the P/E-to-yield divergence is wider at L3Harris. 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, Not Anchor
Damodaran Aerospace/Defense sector aggregates (Jan 2026):
| Metric | Sector aggregate |
|---|---|
| Forward P/E | 45.87x |
| Trailing P/E (profitable firms) | 35.27x |
| EV/EBITDA (positive EBITDA) | 21.58x |
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) all sit below the 35.27x profitable-firm aggregate. That gap says more about the Damodaran sample, which is diluted by smaller loss-making names, than about the primes themselves.
FCF yield has no published sector benchmark in primary sources. The 3-5% band above is anchored on the six filed peers rather than on Damodaran.
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)
- USD FCF yield: (~£2.2B × 1.3387) ÷ ~$78.3B ≈ 3.7%
- Trailing P/E on underlying profit (USD): ~25x
Restate both cap and FCF at the same FX rate and date before comparing BAE to a US peer. The BAE profile covers the GBP/IFRS reporting differences.
Worked Comparison: LMT vs RTX
Both are large-cap, US-listed, defence-exposed names, but the FCF yield and P/E screens read differently for each because the market is pricing a different mix into each cap:
| LMT | RTX | |
|---|---|---|
| FY2025 revenue | $75.0B | $88.6B |
| Defence share | ~99.6% govt | 52% defence |
| FY2025 FCF | $6.9B | $7.9B |
| Market cap | ~$122B | ~$242B |
| FCF yield | ~5.7% | ~3.3% |
| Trailing P/E | ~24x | ~36x |
| FCF conversion | 138% | 118% |
RTX generates more absolute FCF but at a ~$242B cap that also prices in the commercial aerospace recovery running through Pratt & Whitney and Collins Aerospace. LMT generates less FCF on a smaller cap with near-pure government revenue. The conversion ratios in the table above explain most of the gap between each company’s own P/E and yield; the gap between the two companies’ yields instead reflects how much growth the market is pricing into each cap, something the FCF yield does not itself measure.
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 was cited by management at roughly 1.2x, a figure from the earnings call rather than 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
- Pull FY2025 FCF from the earnings exhibit (company-defined, not your adjusted figure).
- Use valuation-date market cap (shares × price); restate BAE at the stated FX rate.
- Compute FCF yield and trailing P/E side by side.
- Check FCF conversion against the house bands: above 90% strong, 70-90% normal, below 70% investigate before treating the yield as reliable.
- Compare the yield to the screening bands (<3% / 3-5% / >5%) rather than to the Damodaran sector P/E.
The Lockheed Martin profile is the platform-concentration case, filed at 138% FCF conversion. L3Harris is where P/E and FCF yield diverge furthest because of conversion. RTX is the dual defence-and-commercial comparator.
Funded backlog and FCF conversion are the inputs. This primer takes them to a ten-year cash-flow value and an FCF yield you can screen.
The Excel model is the primer's two archetype builds live across 11 sheets: a ten-year, backlog-driven free-cash-flow DCF with a Gordon terminal. Change the book-to-bill, the FCF conversion ratio or the WACC and the value per share moves; the backlog, conversion-bridge and concentration sheets update alongside it.
Frequently Asked Questions
- How do you calculate FCF yield for a defence prime?
- FCF yield is free cash flow divided by market capitalisation (or FCF per share divided by share price). Use filed FCF and a valuation-date market cap, not a stale cap from an old model date. Lockheed Martin's FY2025 FCF was $6.9B against a ~$122B market cap on 10 June 2026: $6.9B ÷ ~$122B ≈ 5.7%.
- What are the screening bands for FCF yield on mature US primes?
- We use a house convention, not a published benchmark, because no filed sector FCF-yield figure exists: below 3%, 3-5%, and above 5%. Five of the six FY2025 filed primes landed inside the 3-5% band; one sat above it. The bands describe where filers clustered in one year: conversion, backlog cover and programme concentration all move the number for reasons that have nothing to do with mispricing.
- Why cross-check P/E with FCF yield on defence stocks?
- Long-cycle contract accounting inflates or deflates EPS relative to distributable cash. L3Harris's trailing P/E was ~36x on 10 June 2026 while its FCF conversion was 170%, so its ~4.8% FCF yield tells a different story than the P/E alone. Lockheed Martin's conversion was 138%, giving a ~24x P/E alongside a ~5.7% FCF yield. Damodaran's Aerospace/Defense sector trailing P/E was 35.27x (Jan 2026), skewed by 50.6% loss-making firms in the sample; prime trailing P/Es span ~19-36x, all below that sector aggregate.
- How do you compare BAE FCF yield to US primes?
- BAE reports in GBP. Convert FCF and market cap to a common currency before comparing. At GBP/USD 1.3387 on 10 June 2026, BAE market cap was ~£58.5B (~$78.3B) and FY2025 FCF was £2.2B, yielding ~3.7% in USD. Restate cap and FCF at a single FX rate and date; do not mix FX dates across peers.