Benefits and risks of investing in defense stocks
There are pros and cons to investing in defense stocks. Here are some factors to consider before adding them to your portfolio.
Benefits
- Stable and predictable demand from a customer that invests in national security at all stages of the cycle.
- Long-term contracts give management teams strong revenue visibility, enabling planning and providing stability.
- High barriers to entry due to the specialized nature of the products and the difficulties of governmental regulations and contracts.
- A history of technological innovation that can translate outside of defense. From Velcro to the internet, many of the products we take for granted today originated either within or adjacent to the aerospace sector.
Risks
- Politics can be unpredictable, and changes in government priorities or a new administration can force management teams to rethink their long-term planning.
- Cost overruns are increasingly a problem for the contractor. If a company is not well run and does not keep its costs under control, it can eat into earnings.
- Supply chain chaos can lead to program delays. Large defense platforms rely on dozens of suppliers, each with layers of smaller vendors beneath it. An issue anywhere in that chain can lead to cost overruns or delays for the entire program.
- Ethical concerns are a common reason to avoid defense stocks. These companies make lethal weapons, and not all investors want that in their portfolio.
Methodology: How these stocks were chosen
There is a growing number of defense and defense-adjacent stocks to choose from, including start-ups with exciting plans for the future. But government procurement is a ruthless game, and the large prime contractors that know the Pentagon best tend to secure much of the revenue.
We leaned heavily on the primes when compiling this list, while still trying to include some younger, higher-growth-potential stocks like AeroVironment and L3Harris to capture upside.
One thing you won't see here: start-ups with very little revenue. Although some of these companies have the potential to rise through the ranks, they need to survive basic training before they make the cut as investment candidates.
Should you invest in defense stocks?
Defense companies manufacture lethal products and may support operations or intelligence-gathering that some find unsettling. Some investors don't want to support those activities and may avoid becoming shareholders in defense stocks.
Like many industrial stocks, defense stocks tend to be more plodding than high-flying technology or biotech stocks. But that also means they're less volatile than some sectors. Defense stocks are best suited to income-oriented investors seeking steady growth and rising dividends rather than immense valuation increases.
