Huntington Ingalls’s stock price has taken a beating over the past six months, shedding 20.7% of its value and falling to $206.40 per share. This was partly driven by its softer quarterly results and might have investors contemplating their next move.

Is now the time to buy Huntington Ingalls, or should you be careful about including it in your portfolio? Get the full breakdown from our expert analysts, it’s free.

Despite the more favorable entry price, we're sitting this one out for now. Here are three reasons why HII doesn't excite us and a stock we'd rather own.

Why Do We Think Huntington Ingalls Will Underperform?

Building Nimitz-class aircraft carriers used in active service, Huntington Ingalls (NYSE:HII) develops marine vessels and their mission systems and maintenance services.

1. Weak Backlog Growth Points to Soft Demand

Investors interested in Defense Contractors companies should track backlog in addition to reported revenue. This metric shows the value of outstanding orders that have not yet been executed or delivered, giving visibility into Huntington Ingalls’s future revenue streams.

Huntington Ingalls’s backlog came in at $48.71 billion in the latest quarter, and over the last two years, its year-on-year growth averaged 1.6%. This performance was underwhelming and suggests that increasing competition is causing challenges in winning new orders.

2. Free Cash Flow Margin Dropping

Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.

As you can see below, Huntington Ingalls’s margin dropped by 7.7 percentage points over the last five years. This along with its unexciting margin put the company in a tough spot, and shareholders are likely hoping it can reverse course. If the trend continues, it could signal it’s becoming a more capital-intensive business. Huntington Ingalls’s free cash flow margin for the trailing 12 months was breakeven.

3. New Investments Fail to Bear Fruit as ROIC Declines

ROIC, or return on invested capital, is a metric showing how much operating profit a company generates relative to the money it has raised (debt and equity).

We like to invest in businesses with high returns, but the trend in a company’s ROIC is what often surprises the market and moves the stock price. Unfortunately, Huntington Ingalls’s ROIC has decreased over the last few years. We like what management has done in the past, but its declining returns are perhaps a symptom of fewer profitable growth opportunities.

Final Judgment

Huntington Ingalls doesn’t pass our quality test. After the recent drawdown, the stock trades at 13.4× forward price-to-earnings (or $206.40 per share). This valuation multiple is fair, but we don’t have much confidence in the company. There are superior stocks to buy right now. We’d recommend looking at the most dominant software business in the world.

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