Defense Stocks Are the Most Defensive

 | Oct 10, 2012 | 1:30 PM EDT
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Yesterday, I was listening to snippets of speeches being given by our two presidential candidates. Unsurprisingly, when it comes to taxation, spending and regulation, their viewpoints are like night and day. Where you find the common ground is the issue of military and the country's defense.

Go back through U.S. history, and despite what rhetoric or actions have been taken with regard to our national security, at the end of the day our defense industry continues to thrive as it should.

My ability to sit in a comfortable office and write these columns, read annual reports and invest in a free-market economy is in large part due to the security and freedom this great nation affords us. Borrowing a word from MasterCard, the privilege to have such freedom and security is priceless.

There are just some expenses you cannot significantly cut back on, regardless of the financial "consequence." In a household, those items include medicine, food and electricity. In the U.S., defense is one such category. Several months ago, when I wrote favorably about such names as Lockheed Martin (LMT) and Raytheon (RTN), they and other defense-related stocks were deemed unattractive investments because of the cutbacks in defense spending. Shares in Lockheed were trading in the high $70s, and Raytheon was changing hands in the mid-$40s. Shares of both are up about 20% since then, despite the uncertainty about cutbacks.

As in any other business, investment decisions should be made on the basis of quantitative fundamentals and the qualitative attributes of the business. Even in an industry as stable as defense stocks, investments shouldn't be made blindly. Yet despite the appreciation in share price, Lockheed Martin currently trades for 11x earnings and yields nearly 5%. The yield is one of the highest you will find for such a strong, well-established business. In fact, Lockheed's yield is a solid one, a half percentage point higher than its peers.

Given the market's voracious appetite for dividends along with a very comfortable valuation, Lockheed is in a pretty good spot today. Given the uncertainty of the upcoming presidential election and the fiscal cliff, defense-related stocks could actually be among the most defensive places to be today. While Lockheed is by no means 100% immune to any spending cuts, I highly doubt that anyone on either side of the political aisle wants to be responsible for harming economic growth in 2013 and beyond. Specific to Lockheed, many of its products such as fighter aircraft and missiles are undoubtedly vital to our military.

General Dynamics (GD), another defense stalwart, yields a solid 3.1% and trades for less than 9x forward earnings. In the near term, the top line may stagnate, but the company's aerospace business continues to do well. Value Line is estimating earnings per share of over $8 in the next two to three years, against a $65 share price today. The dividend is safe and attractive, and the cash flows are not going to disappear. After the healthy run the stock market has had, it's only a matter of time before things cool off -- that's one thing you can be certain about. With incredibly strong dividends and avenues of revenue generation, the defense industry is not as stale as many believe it to be.

Unfortunately, the world isn't getting any safer. As economies and countries continue to develop, increased security becomes more and more vital to not only protecting people but protecting economic stability. And since a healthy economy is crucial to people's well-being, no candidate or party is going to risk jeopardizing that for a couple hundred billion dollars.

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