Very few people like the idea of military conflict, but it is a part of the world that happens. The defense sector exists because of this, with most countries focused on protecting themselves from outside aggression.
Spending here goes up and down over time, but the necessity of the outlay makes it a key part of most countries' spending plans. The United States has one of the largest defense budgets in the world. Investors should focus on the biggest names, which can handle the normal ups and downs in the sector. Two defense contractors that should be on your shortlist are Lockheed-Martin (LMT -0.93%) and Northrop Grumman (NOC -2.79%). Here's why.
Although there are larger companies involved in the military industrial space, Lockheed Martin is really the biggest pure-play name you can buy. It has a huge $115 billion market cap and a fairly generous 2.5% dividend yield (the yield on the S&P 500 Index is a miserly 1.3% today). The dividend, meanwhile, has been increased annually for two decades.
Lockheed Martin's business spans four main divisions: aeronautics ($6.4 billion in first-quarter 2022 revenue), rotary and mission systems ($3.6 billion), space ($2.6 billion), and missile and fire control ($2.5 billion). Basically, it is a one-stop shop for military needs that has been built over time via acquisition and internal development. Given that the U.S. government is, essentially, its main customer, having a diversified list of products and the size to swallow up smaller players to expand into new areas is a core reason to like Lockheed Martin.
The entrenched position it holds is highlighted by its roughly $134 billion backlog of work. This number basically represents long-term contracts that Lockheed Martin has with the government that it will fulfill over time, and it provides a huge amount of consistency to its earnings. While any one quarter or year may fluctuate in an unpredictable way, the backlog provides a line of sight as to what investors should expect. If you want to own the biggest and best, Lockheed Martin has to be on your list in the defense sector.
Lagging a little behind Lockheed Martin size-wise is Northrop Grumman, with a market cap of $70 billion. Northrop Grumman's yield is also a bit miserly at 1.4% or so, though the dividend has been increased annually for 19 years. The yield difference between these two companies really boils down to the fact that Northrop Grumman has a more conservative dividend policy, with a payout ratio that is generally around half that of Lockheed Martin's payout ratio. The takeaway here is that Northrop Grumman's dividend, while lower, is probably more secure.
Northrop Grumman breaks its operations down into four divisions, as well: space systems (roughly $2.9 billion in first-quarter sales), aeronautics systems ($2.7 billion), mission systems ($2.5 billion), and defense systems ($1.3 billion). It, too, has a diversified portfolio that has grown over time via acquisition and internal development. However, based on its first-quarter sales, it is clearly a smaller entity in the defense sector than the giant Lockheed Martin. But don't read too much into that because the main players often work together on projects in various ways.
The key is that Northrop Grumman has the scale to compete along with the biggest names. Its backlog, meanwhile, is a hefty $75.8 billion. So not only can it compete, but it also has a long list of projects it is working on that give investors some certainty that the business can weather any short-term ups and downs.
Current geopolitical tensions have led to stock advances for Lockheed Martin and Northrop Grumman, even as the broader market has been selling off. This is about what you would normally expect of the defense group as a whole. That said, if you want to invest here, you should probably be thinking long-term and focusing on the biggest, most diversified names as geopolitical tensions rise and fall over time. Lockheed Martin and Northrop Grumman are two of the biggest and most diversified defense names. Either of these industry leaders would likely be a good option for a buy-and-hold investor with a long time horizon, though Lockheed Martin would likely be more appealing to dividend-focused investors.