"North Korea best not make any more threats to the United States. They will be met with fire and fury like the world has never seen."
-- President Donald Trump
When the Commander in Chief of the most powerful military in the world is making comments like the one above about another nuclear-armed nation, it's quite understandable that you'd be seeking shelter in the defense sector. Perhaps unsurprisingly, defense stocks are one of the few areas of the market that tend to respond well to threats of global war (although there's always Hormel, maker of Spam, which is said to be able to survive even a nuclear holocaust).
Moreover, President Trump is in favor of increasing defense spending by tens of billions of dollars, as well as boosting weapons sales to America's allies, both of which bode well for the companies that supply these militaries. But which business stands to profit most -- and which is best poised to reward investors over the long haul? Read on to find out.
The F-35 Lightning II. Image source: Lockheed Martin.
One of the largest and most important defense programs is the F-35 Lightning II stealth fighter. The fifth-generation jet will replace legacy fighters for the U.S. Air Force, the U.S. Navy, the U.S. Marine Corps, and 10 other countries around the world.
The F-35 is expected to remain in service through 2070, or more than five decades from today. During this time, between the money it earns building, selling, servicing, and upgrading these planes, analysts estimate that the F-35 will generate in excess of $1 trillion in revenue for Lockheed Martin (LMT 0.70%), the largest U.S. defense contractor. For a business with $47 billion in revenue in 2016 -- of which the F-35 accounted for 23% -- this program represents a tremendous growth driver over the next half-century.
Moreover, the F-35 is destined to be "the last manned fighter" that the U.S. military will ever build, according to former Chairman of the Joint Chiefs of Staff Admiral Michael Mullen. So there's unlikely to be much in the way of competition for Lockheed, especially when older fourth-generation fighters begin to be replaced en masse.
Most important, after years of intense criticism, the F-35 has begun to win accolades for its performance during simulated combat exercises. That's vital, for if this program is to fulfill its potential for both American taxpayers and Lockheed investors, the F-35 must give our pilots what they need to accomplish their missions. Fortunately, it appears to be well on its way to doing just that.
When everything is expensive, buy the best
I should note that, as my colleague Rich Smith explains, Lockheed -- and the defense industry as a whole -- is trading well above its historical valuation right now. Specifically, Lockheed's current price-to-sales ratio is 1.78, while its long-term average P/S ratio is typically around 1. That's certainly a big variance from the norm.
But in times of heightened valuations, I tend to gravitate toward the businesses with the strongest competitive advantages. That's because even if you buy them at a relatively high price, strong businesses can eventually grow into their valuations. And in time, they can grow their intrinsic values far beyond the price you originally paid, earning you hefty profits along the way. Weaker companies, however, may not even survive over the long term, making their stocks a particularly risky bet when prices are inflated. So if you're looking to invest in the defense sector, I'd stick with the best businesses -- and Lockheed Martin is at the top of the list.
