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Forget the "Mother of All Bombs": 3 Defense Stocks to Own No Matter What Happens Abroad

By Rich Smith - Apr 23, 2017 at 8:13AM

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Headlines come and go, but these stocks have a longer time horizon.

First came the Tomahawks -- 59 of them, launched at a military airfield in Syria. Then came the bombing of an ISIS cave fortress in Afghanistan. With every passing week, it seems, Americans get another introduction to the weapons that make up the arsenal of democracy. (Next week, it could be aircraft carriers in Korea...)

Of course, this week the talk is all about the Air Force's GBU-43/B "MOAB." Officially designated the Massive Ordnance Air Blast bomb, MOAB has been more popularly christened the "Mother of All Bombs" -- which works just as well for the acronym.

MOAB bomb on a transport trolley.

MOAB on the move. Image source: U.S. Air Force.

At 30 feet long and 40 inches in diameter, MOAB is the largest nonnuclear bomb in the U.S. arsenal. It weighs 21,715 pounds -- 18,739 pounds of which is warhead -- more than 10 full tons. It's so big that conventional bomber aircraft can't even carry it.

Instead, MOAB must be loaded into the hold of a C-130 transport, then pushed out the back door for delivery. Exploding in the air above its target, MOAB unleashes a blast equivalent to 11 tons of TNT going off at once, incinerating everything within one mile of ground zero.

But here's perhaps the most surprising thing about MOAB, for investors: No one company seems to make it.

Whence came MOAB?

Designed by the Pentagon's Air Force Research Lab, MOAB is put together at the government-owned-and-operated McAlester Army Ammunition Plant in Oklahoma. You might think the Pentagon would have contracted a professional munitions maker such as General Dynamics (GD 2.65%) to put MOAB together. Instead, the Air Force built MOAB itself. Why?

It could be that the Air Force never asked; it could be that defense contractors simply weren't interested. You see, as big as an individual MOAB may be, the MOAB program itself was vanishingly small. Only 15 MOABs were ever produced, and two of those were used for testing. The MOAB dropped in Afghanistan was the third -- which leaves just a dozen MOABs in the Pentagon's arsenal (as far as we know).

In any case, to date, it seems that not a single contract to build additional MOABs has been awarded to any private defense contractor, ever. So, while MOAB may be dominating headlines right now, it's not a program likely to help any defense stock's bottom line.

Three defense contractors you can count on

If headlines can't be relied upon to reveal promising investments, what is a better way to invest? Personally, I use common sense.

Let's start with the Constitution. The U.S. Navy is the only branch of the military specifically authorized by the Constitution (Article I, Sec. 8) to be maintained as a standing force. It's also, I think, the one branch of the military most likely to receive steady funding in all international environments -- both in times of war and in times of peace.

Why? Simply because of its mission. America needs a full-strength Navy in both war- and peacetime to ensure freedom of navigation, to protect commerce from pirates (yes, pirates still do exist), and to "show the flag" to prevent conflicts between other nations from happening. These missions ensure a steady flow of funding to the Navy to build new ships and keep the fleet operational and in good repair. They also, I feel, insulate the Navy somewhat from defense spending cuts in times of international tranquility.

To my mind, this makes the three biggest naval contractors -- General Dynamics, Huntington Ingalls (HII 2.54%), and Lockheed Martin (LMT 2.05%) -- three of the most reliable defense contractors to invest in. General Dynamics builds submarines and destroyers for the Navy. Huntington Ingalls' specialty is aircraft carriers and amphibious assault vessels -- although it builds submarines and destroyers as well. Lockheed Martin builds aircraft, of course, including the Navy's new F-35C stealth fighter jet and the Marine Corps' F-35B. But Lockheed also has contracts to build Littoral Combat Ships for the Navy.

Speaking of shipbuilding contracts, in contrast to other weapons systems that can be built in a day, or several days, it takes several years to build a complete warship from the keel up. Your average Virginia-class nuclear submarine, for example, can take General Dynamics or Huntington Ingalls two years to complete. The nuclear-powered supercarriers that Huntington builds take even longer -- about five years each.

These long timelines mean that when a naval defense contractor wins a contract, investors can map out future revenues, and estimate future profits, several years into the future -- which lends a bit of certainty to an investment. It's one thing I like about investing in the naval contractors.

Caution: Caveats ahead

What don't I like? Honestly, I find the stocks of the shipbuilders, like most defense contractors these days, unattractively valued at present. While not the most egregiously priced stocks in the defense industry, General Dynamics, Huntington Ingalls, and Lockheed Martin currently sell for valuations far above the "one times sales" valuation that I use as my rule of thumb for fair value in a defense stock.

However, this is only a temporary obstacle to investing in the defense industry, where valuations tend to move in cycles. (For an illustration of what the industry looks like when defense is out of favor, check out the articles I was writing seven years ago -- when defense stocks were consistently underperforming the S&P 500.) Although they're expensive today, there will come a day when defense stocks are undervalued again.

And now you know which stocks to invest in once that day arrives.

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Stocks Mentioned

General Dynamics Corporation Stock Quote
General Dynamics Corporation
GD
$222.33 (2.65%) $5.73
Lockheed Martin Corporation Stock Quote
Lockheed Martin Corporation
LMT
$419.04 (2.05%) $8.42
Huntington Ingalls Industries, Inc. Stock Quote
Huntington Ingalls Industries, Inc.
HII
$215.34 (2.54%) $5.34

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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