The Cold War is long over. The peace dividend has been spent. Thirty-six years after the fall of the Berlin Wall, however, the world somehow feels more dangerous than ever before. There's conflict in the Middle East, border wars in Southeast Asia, artificial islands springing up across the South China Sea, and of course ... the largest land war in Europe since World War II continues to grind on.
Think now might be a good time to invest in some defense stocks?
Well, so do I -- and apparently, so do a lot of people! For months, I've been warning that defense stocks are getting increasingly expensive as investors glom onto the global trend of growing military budgets. The good news is that, while defense stocks as a whole are getting pricey, there are still a few relative bargains to be found in this sector.
If you have $500 available to invest, here are two that approach my self-defined standard of what constitutes a good price for a defense stock: Textron (TXT +0.33%) and Huntington Ingalls (HII 0.18%).
Image source: Getty Images.
Get to know Textron
Textron may be less well-known than some of the larger defense contractors, but you almost certainly know some of its brands. The company's biggest division, Textron Aviation, produces Cessna and Beechcraft aircraft, for both civil and military customers. Similarly with Bell Helicopter, the company's second-largest division by revenue. In partnership with Boeing, Bell also builds the V-22 Osprey tiltrotor aircraft for the U.S. Marine Corps.
On the ground, Textron Systems builds M1117 armored cars for the Army, LCAC 1000 hovercraft for the Navy, as well as the RIPSAW M5 robotic tank (developed by now-Textron subsidiary Howe & Howe).
Priced at $15.8 billion in market capitalization, Textron stock sells for an unassuming 19 times trailing earnings. Although somewhat more expensive when valued on free cash flow (22.7 times FCF), the stock's price-to-sales ratio sits very close to my preferred one-times-sales valuation for U.S. defense stocks -- just under 1.1.
Out of all the defense stocks I track, Textron is one of the two cheapest by this metric.
NYSE: TXT
Key Data Points
Get to know Huntington Ingalls
Slightly cheaper than Textron is Huntington Ingalls. And for those unfamiliar, Huntington is the former military shipbuilding arm of Northrop Grumman, which was spun off from the parent defense contractor in 2011. The stock price is up 8-fold since its spinoff, by the way, despite its sales having barely doubled -- a good object lesson in the value of patience for Northrop and for investors alike.
Huntington Ingalls today is one of the U.S. Navy's primary shipbuilders. It specializes in the construction of both nuclear-powered aircraft carriers and nuclear submarines, while also building an assortment of amphibious assault ships, destroyers, and cutters for the U.S. Coast Guard. So long as the South China Sea remains a focus of U.S. defense policy, the company can expect a steady flow of revenue as the U.S. Navy attempts to keep pace with an ever-expanding People's Liberation Army (PLA) Navy -- already the largest navy in the world.
Priced at just over $13.2 billion in market capitalization and with $12 billion in annual sales, Huntington Ingalls' stock (like Textron) costs about 1.1x annual sales valuation. But it costs more for good reason.
Up until late last week, you see, Huntington Ingalls was trading significantly below Textron on valuation. But on Friday, the U.S. Navy announced it has chosen Huntington to design and build a new "small surface combatant" warship to replace the fleet of Fincantieri-built Constellation-class frigates that the Navy just canceled. The Navy chose Huntington's established design for Coast Guard National Security Cutters to form the basis of this new frigate -- and Huntington Ingalls' stock promptly popped more than 4%.
NYSE: HII
Key Data Points
Why I prefer Huntington Ingalls
It's not known precisely how much this new contract will be worth to Huntington Ingalls. But it's worth noting that the Constellation program was originally intended to build at least 20, and potentially three times that number of frigates for the Navy. Now, Fincantieri will build only two Constellations -- which means there's a whole lot of room for the Navy to accept new frigates from Huntington instead, and a lot more potential for revenue growth at Huntington.
Both these stocks are cheap enough that they should be no-brainers for patient defense investors. But of the two stocks, if I had to invest $500 in just one, I must say I like Huntington Ingalls the best.
