Aviation Stocks Soar on Buffett, Graham Value Radar

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NEW YORK ( RealMoney) -- Doom and gloom -- that's all one seems to hear today about the economy, the stock market and, indeed, the future. In fact, while the economy is shaky and the markets are gyrating like teenagers in a dance contest, not all companies and industries are suffering equally -- and some aren't suffering at all.

We should not assume today's economy produces only losers and no winners. Even the Depression produced winners, such as the Hollywood movie studios and Chevrolet, which took over the No. 1 spot among carmakers from Ford ( F) during the early 1930s. And while the economy is weak today, the country is not in a depression.
Aviation stocks exhibit several of the qualities prized by value investing masters Warren Buffett and Benjamin Graham.

The fact that sunshine is shining on some areas of the economy was highlighted recently when United Technologies ( UTX) announced its purchase of aircraft component maker, Goodrich ( GR). Goodrich, once known for its tires, got out of the tire business over 20 years ago. United Technology's CEO was quoted in The Wall Street Journal as saying, "'We're on the eve of a substantial ramp-up for the commercial aviation industry." And United Technologies is not getting Goodrich on the cheap. It paid a 47% premium above Goodrich's price before the rumors of the takeover began.

My guru strategies are based on the writings of some of history's best investors, and consist of several companies whose businesses include the commercial aviation market, among them, Triumph Group ( TGI). According to the company, it "designs, engineers, manufacturers, repairs and overhauls a broad portfolio of aerostructures, aircraft components, accessories, subassemblies and systems." The company sells to both aircraft manufacturers and airlines.

Peter Lynch is a legendary mutual fund manager, and he wrote about how he invests in his bestseller, One Up on Wall Street. After reading this book, which I highly recommend, I computerized the steps he described in his strategy. The key to this strategy is the price-to-earnings growth (PEG) ratio, which looks at the price to earnings ratio (P/E) relative to growth and measures the price the investor pays for growth given the stock's current price. Triumph's yield-adjusted PEG is 0.66, based on the average of the three-, four- and five-year historical earnings per share (EPS) growth rates. This is well below the 1.0 maximum allowed by the strategy and means the investor is buying growth at a fairly low price. In addition, the company is doing a good job managing its inventories.

The estimable Warren Buffett also has a strategy that I have automated and it identified another aviation-oriented company worth considering. Rockwell Collins ( COL) makes electronic communications, avionics and in-flight entertainment systems used in both commercial and military aircraft. The Buffett-based strategy expects that Rockwell will fly high because it is a major player in its markets, holds an amount of debt equal to less than a year's worth of earnings, produced a return on total capital over the past decade in excess of 28% annually and generates positive free cash flow per share. These are all strong positives. The strategy also calculates an investor's anticipated likely annual rate of return when buying the stock, and with Rockwell, it projects a solid 16.1% return. The sky may be falling on some companies, but not likely on Rockwell.

Moog ( MOG.A) manufacturers flight control systems, avionics instruments and radar system, as well as addressing such non-aviation markets as dentistry and hospitals. (Do not confuse it with Moog Music, which makes electronic musical instruments.) Warren Buffett's teacher and employer was Benjamin Graham, the father of investment strategists, and my Graham-modeled strategy recommends Moog, based on its high degree of liquidity (its current ratio is 2.65:1), moderate amount of long-term debt and modest P/E ratio (13.4). The strategy also multiplies the price-to-book ratio (P/B) by the P/E, the product of which must not exceed 22. Moog's price-to-book ratio (P/B) is 1.12, which when multiplied by the P/E, comes to a very reasonable 15.01.

However weak the economy, these aviation companies are flying high and far. Consider them all for your portfolio.

At the time of publication, John Reese and his clients were long Triumph Group.

John P. Reese is founder and CEO of Validea.com, an investment research firm, and Validea Capital Management, an asset management firm serving affluent investors and companies. He is also co-author of two investing books, including The Guru Investor: How to Beat the Market Using History's Best Investment Strategies (Wiley). Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Reese appreciates your feedback. Click here to send him an email.

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