Defense stocks tend to be predictable, boring dividend-payers but can light up during times of strife. After several years of the U.S. not engaging in any new conflicts, we may be entering one of those periods again.
President Biden insists Russia is about to invade Ukraine -- despite denials by both countries that any attack is imminent -- and is deploying 3,000 troops to Poland and shifting 1,000 troops from Germany to Romania in a show of support for our NATO allies. .
Whether there is ultimately a confrontation remains to be seen, but defense contractors are moving front and center again as a good offense is predicated on having a strong defense. All the saber-rattling makes it a good time to look at defense stocks, and the following two contractors look poised for a bull run.
Image source: Getty Images.
1. Northrop Grumman
Northrop Grumman (NOC 1.37%) is one of the world's largest defense contractors and the fourth-largest in the U.S. with some $31.4 billion in 2020 Defense Department revenue -- 85% of Northrop's total revenue, according to the latest data available.
However, few defense contractors have a portfolio of national security programs as closely aligned with the military's broad goals as Northrop. It is tasked with modernizing the country's ground-based leg of its nuclear weapons triad, replacing the Minuteman III intercontinental ballistic missiles (ICBMs) with state-of-the-art, next-generation ICBMs.
Northrop's technological capabilities have put it in the forefront of cybersecurity for the military, using artificial intelligence and machine learning in its C4ISR Division -- Command, Control, Communications, and Computers (C4) Intelligence, Surveillance, and Reconnaissance.
It's also leading the government's space security efforts and assisting civilian and commercial space pioneers leading NASA's James Webb Space Telescope, which replaced the Hubble telescope.
An earnings miss caused by global supply chain issues and the labor shortage has the stock valued at just nine times trailing earnings, 14 times next year's estimates, and less than twice its sales, making it the least-expensive stock among the prime defense contractors.
Northrop also maintains a shareholder-friendly policy of returning most of the free cash flow it produces -- over $2.1 billion in 2021 -- to investors through stock buybacks and dividends. The payout currently yields 1.6% annually. It's not the most lucrative dividend, but it is reliable. The defense contractor has paid a dividend since 1990 and increased it every year since 2004.
Image source: General Dynamics.
2. General Dynamics
Like Northrop Grumman, defense contractor General Dynamics (GD 1.34%) is positioned to capitalize on the military's need for advanced weapons systems and technology while also mixing in a healthy dose of civilian income streams. This diversity helps provide a buffer in the event of changing political whims.
Arguably best known for its M1 Abrams battle tank, General Dynamics also produces the Stryker family of combat vehicles, light armor vehicles, and nuclear attack and ballistic missile submarines.
The military contractor could just as well be seen as a tech stock, as its technology division is its largest business. It accounts for 33% of sales, albeit targeted for military preparedness.
Positioned just behind Northrop as the fifth-biggest defense contractor, it had $26.8 billion in military revenue in 2021, representing 70% of total revenue.
Image source: General Dynamics.
But it is General Dynamic's aerospace segment, which has become a leading producer of business jets through its Gulfstream unit, that provides some needed variety. That business is subject to economic downturns, though. While the segment was one of the primary causes for the defense contractor lagging behind its peers over the past few years, Gulfstream is positioned to take flight.
In its recent quarterly earnings conference calls, chairman and CEO Phebe Novakovic said the aircraft unit was enjoying "extraordinary order activity," following orders in the third quarter that "bordered on the spectacular." This has been the best order performance the company has seen since 2008.
The aerospace segment generated $8.1 billion in revenue last year, and General Dynamics realizes 20% of sales from U.S. and international commercial customers.
General Dynamics also pays a dividend that yields a healthy 2.2% annually. Though its stock is valued at higher multiples than Northrop Grumman, it still represents a good value at 18 times earnings and 1.5 times sales. It is a defense stock that will have healthy growth for years to come, and its stock should charge forward too.
