6 Stocks That Never Surrender

Is the housing market out of foreclosure? Has the recession ended? My Foolish colleague Jennifer Schonberger took the Bear's temperature earlier this week and came away with a resounding "perhaps ..."

But it's hard to deny the presence of green shoots this week. Warren Buffett bought a train set for Christmas last week, and no sooner had Buffett unwrapped his present than we saw a spurt of follow-on transactions:

And speaking of profits ...

Company

Starting Price*

Recent Price

Total Return

General Dynamics (NYSE: GD  )

$51.24**

$66.72

30.2%

Raytheon (NYSE: RTN  )

$41.99**

$48.56

15.6%

Lockheed Martin (NYSE: LMT  )

$77.69**

$74.10

(4.6%)

AeroVironment

$29.96

$27.82

(7.2%)

iRobot

$11.49

$13.45

17%

Force Protection

$4.57

$5.17

13.1%

AVERAGE RETURN

 

 

10.7%

S&P Spyder

$87.75**

$109.03

24.3%

DIFFERENCE

 

 

(13.6)

Source: Yahoo! Finance.
*Tracking began on July 10, 2009. Portfolio is equal-weighted, with "recent price" being set at market close on the Thursday preceding publication, and adjusted for stock splits and dividends.

Defense investors still aren't seeing a lot of 'em, relative to more investors in the more diversified S&P 500 index. We did hold our own this week as General Dynamics and Force Protection posted strong gains. What's the industry's secret to holding its own in a down market? Three words: Profits, contracts, and valuation.

A Force to be reckoned with
Force Protection took the lead for our portfolio this week, beating earnings estimates Monday and turning in "adjusted earnings" of nearly twice what it analysts were expecting from the company. The firm's still cranking out Buffalo minesweeping MRAPs for the U.S. military, and building Wolfhounds for our British allies.

Plus, Force hasn't written off its Cheetah MRAP as entirely toothless. While it's been stymied trying to sell the vehicle to the Pentagon, Force argued this week that it's identified "several potential customers beyond traditional military customers," naming "Homeland Security, private security contractors and NGOs" as three potential target markets. We'll see ...

Spinners and winners
Do I sound just a wee bit suspicious of Force Protection's Cheetah-happy talk? If so, I trust you'll understand why. The company has pushed its zippy armored car as the solution to nearly every major Pentagon vehicle program from the original MRAP program, to MRAP-lite, to JLTV in between -- all for naught.

Meanwhile, the actual winners in these contests are raking in the big bucks. Navistar for example, landed $426 million in new contracts this week, tasked with building another 1,928 medium tactical vehicles for the Army, and providing maintenance services on its exiting fleet of International MaxxPro MRAPs. Meanwhile, the victor in the MRAP-Lite contest, Oshkosh, scored another 1000 M-ATV contracts -- and an additional $438 million in revenues.

Armor-plated companies, indefensible valuations
But perhaps the biggest reason for optimism about defense stocks this week came as we got a glimpse at what their true value might be. Private equity titans General Atlantic LLC and Kohlberg Kravis Roberts agreed Monday to purchase Northrop Grumman's government consulting division for $1.65 billion. Since this "TASC" division is expected to book $1.6 billion in revenues through the end of this year, this implies a valuation of almost precisely one times sales.

Why is this significant? Precisely because, in years past, defense contractors with respectable profit margins and growth prospects traded for this very valuation: 1 times sales. Yet today, we're seeing Boeing (NYSE: BA  ) and Textron shares offered for as little as half that valuation, while even the highest-valued defense contractors, firms like General Dynamics, still sell for P/S ratios as much as 20% below "normal."

Foolish takeaway
Is this proof positive that defense stocks have been massively oversold and are due to bounce back?

No ... but it is a billion-dollar-plus bet on the industry -- by some of the smartest guys in the room.

Looking for other high-tech defense prospects for your portfolio? Check out Motley Fool Rule Breakers, where we're looking into options in everything from UAVs to missile defense, from bombproof trucks to bulletproof soldiers. Thirty-day free trials are available on-demand.

Fool contributor Rich Smith likes a lot of these stocks so much that he "bought the company" -- Force Protection, Boeing, and AeroVironment to name a few. AeroVironment and iRobot are Motley Fool Rule Breakers recommendations. General Dynamics and Intel are Motley Fool Inside Value picks. Why do we tell you this? Because The Motley Fool has a bulletproof disclosure policy, that's why.


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