Should You Invest in Defence Stocks?

In our latest EasyResearch feature, we have the awesome Chuck Saletta (contributor to Motley Fool) sharing some insights on General Dynamics, Lockheed Martin and Leidos Holdings. In a world where war is a reality, being well prepared for it can both serve as a deterrent and provide a potential path for a civilization to survive it.

War is a very expensive proposition on many levels. The cost in lives, property damage, and environmental concerns can be catastrophic. Even for the survivors, once it’s over, there are likely ongoing costs in terms of injuries, mental trauma, and the challenges of rebuilding from a shattered foundation.

Yet as awful as war is, the reality is that it has been a part of human existence for over 10,000 years. Those that don’t prepare for it are likely to become the targets of those that do. Given that somber truth, it makes sense to consider defense contractor stocks through the lens of former US President Theodore Roosevelt. His famous saying, “Speak softly, and carry a big stick” refers to the value of having a strong military, not just to actively fight wars, but also to deter attacks from potential enemies.

Indeed, investors in defense contractors should consider the value of the companies both in times of war and in times of relative peace. During times of peace, after all, there is still a need for training, maintenance, repairs, and upgrades of military equipment. 

In addition, if you’re dependent on high wartime spending to support your valuation estimate of a defense contractor, you risk being disappointed after the fighting ends. That’s never a place you want to find yourself, for a lot of reasons.

There’s clearly a tough balancing act involved in successfully investing in defense contractors. With that in mind, here are three top defense contractors to consider.

No. 1: General Dynamics (NYSE: GD)
Perhaps best known as the lead contractor on all US Navy nuclear powered submarines, General Dynamics also makes the Abrams tank. In addition to its defense operations, major business leaders also know General Dynamics for its Gulfstream jets. 

From a valuation perspective, General Dynamics recently traded hands at 16.4 times its projected earnings, with those earnings estimated to grow by around 9% annualized over the next five years. Add to that a decent dividend yield around 2.1% that consumes around 44% of the company’s earnings, and General Dynamics looks like a reasonably priced business in a tough industry.

General Dynamics
No. 2: Lockheed Martin (NYSE: LMT)
Famed for its “Skunk Works” rapid aircraft design facility, Lockheed Martin plays a leading role in equipping the US Air Force with technologies like the F-35 fighters. Fitting for a business associated with attempting to win air superiority, Lockheed Martin is also developing hypersonic missile solutions.

Not too far off from a valuation perspective from General Dynamics, Lockheed Martin recently traded hands at just under 17 times its anticipated earnings. Analysts expect a slightly stronger five-year earnings growth rate of 10.7% annualized, which could compensate for that slightly richer price if that superior growth materializes. Lockheed Martin’s 2.8% dividend yield consumes around 44% of its earnings, and its most recent dividend declaration marks 21 consecutive years of boosting that payment.

LockHeed Martin
No. 3: Leidos Holdings (NYSE: LDOS)
As warfare morphs to cyberwarfare and digital attacks and defenses become more important, Leidos Holdings is a key leader in that field. From autonomous vehicles to command and control systems and “full spectrum” cyber capabilities, Leidos Holdings plays a key role in providing digitized solutions for military and civilian needs.

Thanks to an earnings recovery expected over the next year, Leidos Holdings trades at slightly under 14 times its anticipated earnings, making it the cheapest one of this group by that measure. That said, with analysts expecting earnings to only rise by around 7.9% annualized over the next five years, its expected growth is slightly below its compatriots listed here. Its 1.5% yield is also slightly below both General Dynamics’ and Lockheed Martin’s,  but if its earnings recovery materializes, it may have room to boost that payment.

Leidos Holdings
May we all “speak softly and carry a big stick”

In a world where war is a reality, being well prepared for it can both deter attacks and improve a civilization’s chance at surviving it. Defense companies play a key role in that preparedness, and as such, they may be reasonable investments even in times of peace. As a potential investor, it makes sense to consider that entire cycle and put your money at risk only if you see a reasonable path to long term returns after the world returns to peace.

At the time of publication, Chuck Saletta owned shares of Lockheed Martin.

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