Investor's Guide to Defense Stocks in 2018

What you need to know about investing in defense and aerospace.

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Some of the largest companies in America are those who work in defense of our country and allies abroad. 

Defense contractors including Lockheed Martin, Northrop Grumman and Raytheon have routinely been some of the strongest performers in the stock market, with revenues in the billions and strong returns for investors.

The United States is expected to spend more than $700 billion on defense in 2018 and in 2019.

A good chunk of that will go to major defense firms. These companies will also earn revenues from other government agencies and from international allies.

For the most part, defense stocks have provided consistently strong returns for investors. In many ways, the financial health of these companies is tied to the level of government defense spending, but these firms have also diversified revenue streams that allow them to report strong earnings regardless of what the U.S. decides to spend on defense.

One way to track defense stocks broadly is to follow the S&P 500 Aerospace and Defense Index, which includes the largest companies in the sector.

Let’s examine the nature of defense stocks, some of the major players, and expectations for 2018 and beyond.

More Than Just Defense

In some ways, the term “defense stock” is an incomplete and often inaccurate description for companies labeled as such. In general terms, the term is reserved for companies involved in assisting with our national defense, through the development of weapons systems, fighter jets, technology and other products and services.

But these companies have become so large and diversified that they work with many customers that have little to do with defense. Aircraft manufacturer Boeing, for example, makes a lot of money from the defense department but also makes many of the planes used by commercial airlines. Lockheed Martin is considered the largest U.S. defense contractor, but has a robust space systems unit and has been involved in efforts to land a human being on Mars.

Increasingly, defense contractors have expanded their businesses to include cybersecurity, technologies to combat climate change, or transportation solutions in major cities.

Thus, while it is important to understand how much money these companies make from defense spending, it’s also crucial to know what other revenue streams they have. Many of these firms are more accurately referred to as “conglomerates” due to the large and diverse nature of their businesses.

This diversity has allowed companies to maintain good operational performance—and see share price growth—even as defense budgets rise and fall. For the most part, these are solid and well-run companies that can withstand cuts to defense spending and the political turmoil that often accompanies it.

Possible Headwinds

Current levels of defense spending are a good thing for the industry. But there are some things that could post challenges to some firms. For one thing, many companies are dealing with a shortage of qualified labor. Low unemployment is making it harder for firms to find workers in highly technical fields, such as engineering.

Additionally, while defense spending is strong, cuts to other government agencies could result in fewer contracts for these companies.

Smaller budgets for the Environmental Protection Agency, for example, might mean less revenue for those companies involved in climate change research and technologies.

There is also a general concern that current governmental policies could, over time, result in a slowdown of the economy. For the most part, however, there remains optimism that defense stocks will continue to be strong market performers.

Let’s take a look at some of the major players in the defense industry.

Prominent Defense Stocks

Lockheed Martin [NYSE: LMCO] - This is the Big Daddy of defense firms, born out of the merger between industry titans Lockheed and Martin Marietta.

Lockheed Martin has taken some hits in recent years due to bad publicity surrounding the development of the F-35 fighter jet. But it has maintained strong earnings and revenue growth, reporting more than $51 billion in sales in the first quarter of 2018.

Lockheed Martin’s stock hit an all-time high of $363 in February of 2018 but then dipped through the spring and summer as some analysts warned of a decline in cash flow. Now the company is being viewed by many analysts as a bargain. Rarely in its history has Lockheed Martin seen its stock price decline for more than a few months at a time.

Raytheon [NYSE: RTN]- This Massachusetts-based firm is involved in missile defense, electronic and cyber warfare, plus many advanced technologies serving both governments and commercial clients. It reported more than $6.2 billion in revenue in the first quarter of 2018, representing more than 4 percent growth. That’s solid but trails many competitors. Raytheon’s share price peaked at $230 in May but has fallen below $200. Analysts are still fairly bullish on Raytheon, predicting that prices could rise above $220 or even $230 by year’s end.

Boeing [NYSE: BA]- Airplanes. Rockets. Satellites. Missiles. Boeing is the world’s largest aircraft manufacturer but does a lot more. Revenue rose to more than $24 billion in the first quarter, and the company’s share price is more than 65 percent higher than it was a year ago. Analysts are bullish on Boeing, with some believing there’s long-term demand for commercial jets that will buoy the company regardless of the level of defense spending.

Northrop Grumman [NYSE: NOC] This Virginia-based firm is sliced into four business units: Aerospace Systems, Mission Systems, Technology Services and Innovation Systems. It makes everything from the B-2 bomber to space probes exploring the asteroid belt. It recorded revenues of $6.75 billion in the first quarter of 2018, beating expectation. Its stock price peaked at $360 in the spring and fell to $320, but is still up 18 percent over the last year. Many analysts say Northrop Grumman doesn’t have much in the short-term to push shares back up quickly, but that it will eventually see growth from increase defense spending.

United Technologies [NYSE: UTX] The maker of Pratt & Whitney engines saw its share price rise in the first half of 2018, only to see it settle back down to its previous level. The big news for the company was the completion of its merger with Rockwell Collins. Analysts are generally split on neutral versus buy ratings for the firm, though few think the company is overpriced at this point, and many see the Rockwell Collins merger boosting revenues and share prices over the long term.

General Dynamics [NYSE: GD] The maker of Gulfstream jets and Tomahawk missiles, GD is the fifth-largest defense contractor in the U.S. Shares are down more than 20 percent since a 52-week high in April, after quarterly revenue of $7.5 billion was less than some observers had hoped. Revenue from its aerospace segment was especially sluggish. But analysts believe the company is now one of the biggest bargains out there.