This Stock Might Be a Great AI Play in the Defense Industry

If you're looking for an innovative space to invest in new technology trends, you may want to take a look at the defense market, which is ramping up its investments in artificial intelligence and machine learning. And within that space, General Dynamics (GD 0.63%) might be worth a look. 

In this video clip from "The AI/ML Show," recorded on Feb. 2, Fool contributor Jose Najarro does a deeper dive into General Dynamics' operations and its recent earnings report, and shares some pros and cons about the industry.

Jose Najarro: First, General Dynamics, ticker GD. They operate in four segments, the aerospace, marine systems, combat systems, and technologies. Technologies this one will be their GDIT. Technologies offers cloud computing, artificial intelligence, machine learning products. From everything as, it could be security and operations. It could be anything to also fuel those other segments. Right now, we can see artificial intelligence in the defense market. Like Lou mentioned, it's not going to be the Terminator right now. That's not what's happening right now. It's mainly like decision-making. Something like Lou was mentioned in where we have those preventative maintenance. You can also be using artificial intelligence for either cyber attacks and cybersecurities. These cyber locks, they're not unbreakable, but a normal human can't find the code for them. You need something to be able to either crack the code or make sure the code is always changing. The lock is always changing so no one can get in. You need something fast to do that. Usually, artificial intelligence is the best way to go.

Other things, obviously like the autonomous systems, either in some form of air products, a ground product, or water products, weapon systems, and much more. But I do believe the major ones right now are decision-making, logistics like the preventive maintenance. Also, another way they can save money, say maybe they might be over-ordering too much in certain products, maybe the Army might be ordering too much ammunition at first. A way to save money is instead of figuring out how often they should order, what products and when they should order. General Dynamics, if we take a look at recent news, in the recent fourth-quarter and earnings which they presented Jan. 26, they provided earnings of about 952 million and that was on $10.3 billion in revenues, their margins aren't horrible there. Cash flow from operations were about $1.7 billion for the quarter alone. Then look at this, they have a backlog of about $87.6 billion. The great thing is usually in the defense market, contracts usually last a long time. It's not like, hey, we want you to build something. It's usually takes three to four years, five years, probably even longer to build those products, especially if it's some new innovative market.

Jason Hall: Well, like Lou was talking about earlier. I mean, these things stay in the fleet and operation for decades and decades.

Najarro: Definitely. Then let's say that software that Lou was mentioning how that preventative maintenance. It takes X amount of years to build that software. But then after that, the contractors, they also, hey, we also add X amount of years where we maintain the software, we do any form of updates. It's not just a final product. They also usually have expansions to those products. For anybody really interested in, obviously the known products that are known to the public, general, the United States Army and associations, they usually have a yearly project presentation or showcase.

Last year was on Oct. 6. They mentioned a lot of different products. They use either artificial intelligence, they use autonomous driving. This is all out for general public. If you want to go and check them out, Google General Dynamics at AUSA. That's, I believe, Associates of the United States Army. There's numerous contractors there that are also presenting all the products right now. One of the things that they've also worked, not usually people only think of this general contractors, that's foremost, Army working for defense and attack, but they also work, for example, they just recently got 190 million cloud contracts by the United States Patent and Trademark Office. I'm guessing the way to submit patents, I personally have never submitted a patent, but it might be a very tedious task. I'm guessing General Dynamics is working to make that a little bit easier, a little bit more straightforward, which is good.

Then on Jan. 30, they received about $580 million on global logistics to contract for the United States Army. Again, these logistics, I think this is where artificial intelligence will first fit, will be the main process or the main market in these upcoming years where people are coming into some of these contractors, especially like the government and saying, "Hey, we need to be able to save money. What are some of the ways we can do that?" Logistics, preventative maintenance would be some of the best news for them. If we just take a quick look, General Dynamics in the past year, great returns compared to the overall market.

Then just my overall thoughts, like I mentioned, I do believe this is a very innovative market. I think this is where big tech usually comes in. Unfortunately, most of the time, you don't hear about it because it's usually to some form of clearance of secretive level to it. If you are an investor to some of these companies, sometimes you might not hear about the cool projects that they're working with because there's something behind them. Obviously you might hear just the top level, but all the meat inside of there, obviously for security reasons, you might not hear too much about them. When you are looking for an artificial and machine-learning play, this sector, like I mentioned, top contender, one of the places where most of the money is being spent to develop.

Like I mentioned, Microsoft got a nice contract with them to work on their augmented reality glasses, the HoloLens. I do believe because of contracts like this, in the next 3-5 years, we're going to see a more consumer likable product for their HoloLens and more sleeker, more smaller, something the average consumer would be able to use. Again, projects tend to be long contract. Historically, the company doesn't seem overvalued compared to historical metrics. I think I didn't have it here. I shared the P/E ratio of it, and it's been sitting around the same levels.

One risk, like I mentioned, this is a very innovative market. With a very innovative market, competition is pretty high. General Dynamics has competitors like Harris, Boeing, Lockheed, and the list goes on. I also mentioned numerous projects are secret, so very hard to determine if they can expand to other players. I know sometimes investors like to look at products and like to think, "Hey, this is something that can grow on X, Y or Z." But because of the secretive of some other products, investors might not be able to do that. Another thing, they are very dependent on federal spending. Usually the big players here are the federal government. If you see something like a slowdown in budget, it could affect, I believe, short-term returns to some of these companies. But if they provide great products for their customers, they're going to come back with a bigger bag of cash. Supply chain issues. Some of these big players do offer big equipment. I know General Dynamics is known for their submarines. Those require a lot in a lot of materials. Any type of supply chain issues can definitely affect some of the top-line revenue. Like I mentioned, some of their other segments are the aerospace and the marine systems, combat systems, which usually do include some form of vehicles within that space.