Defense stocks look to have a runway into a profitable future.
Defense budgets are ballooning as global tensions rise, and that’s put defense stocks in the limelight among investors. The argument for picking up a defense company right now is relatively strong.
First there’s the obvious ramp up in global tensions, which has supported demand from governments around the world looking to beef up their military capabilities. But the defense sector also offers some insulation during economic slowdowns.
While belt-tightening is a natural consequence of slow economic growth, rarely do we see defense budgets slashed.
So what makes for valuable defense stocks? One hallmark of the industry is reliable income well into the future. Defense companies make large and lucrative contracts that stretch years and sometimes decades into the future.
The management of these future revenue streams is paramount to their success. With that in mind, it makes sense to look for companies with robust and growing order books who spend that income on growth areas like cyber security, AI and nuclear.
The industry itself is hard to break into, with only a handful of large players making up the bulk of government contracts. That means investors can expect to pick up some “steady eddy” stocks.
But there are also corners of the market that are growing rapidly— particularly when we look at areas like cyber security and AI. Investors are likely to find more growth potential here, but also a hefty dose of risk as well.
BAE (OTCMKTS:BAESY) makes military equipment like aircraft carriers and fighter jets, making it a defense stock worth considering as demand for these items rises amid global tensions.
So far, the group’s seen the benefit of growing defense budgets and that’s helped it to expand its portfolio into potential high-growth areas.
The beauty of making large and complicated jet planes is there are only a handful of companies to compete with. Barriers to entry are high so once you’re set up it’s a matter of quality control and relationship management. But BAE isn’t resting on its laurels.
The group’s order book has swelled to $73.2 billion, leaving the group with plenty of financial firepower to accelerate growth.
BAE’s funnelling some of that into research and development as well as strategic acquisitions. This includes purchases to beef up its Cyber & Intelligence portfolio.
For now, this represents only a small part of the business, but it could become a much more important growth engine in the future.
Lockheed Martin (LMT)
It’s impossible to talk about defense stocks without bringing Lockheed Martin (NYSE:LMT) into the mix. This is the world’s largest defense company thanks to its relationship with the world’s largest defense spender — America.
Lockheed’s been able to take pole position in the industry thanks to industry-leading research that allows it to create fighter planes, missiles and other electronic devices. The group’s one of the top providers of the world’s most expensive airplane, the F-35 Joint Strike Fighter.
With all that in mind, it might sound like growth will be scarce. The group’s been struggling to grow its order book as quickly as investors have become accustomed to and supply chain constraints have weighed.
These problems look likely to resolve in the months ahead, particularly with order book growth, given that defense spending is a top priority these days.
That’s meant the group’s share price has grown little so far this year, making for a worthwhile entry point. Lockheed’s top-dog position means it’s got a layer of security, and as some issues holding back growth clear, the stock could be ready to run.
CAE (NYSE:CAE) is a more specific play among defense stocks. It’s a Canadian company best-known for its pilot training programmes, and it’s not necessarily a pure-play defense stock.
The group makes training solutions for both commercial and military pilots. This is largely using simulator technology, which it has extended into the healthcare space as well.
Notably, the defence sector makes up 44% of overall revenue. Civil aviation is currently the largest part of the business and has been the driving force behind growth of late.
This makes sense given that Covid took a lot of pilots out of circulation, leading to demand for training and up-skilling as flights got back to normal.
The mix of businesses is an important layer of diversification, and healthcare represents an important growth avenue as the group continues to improve profitability there. CAE makes for an interesting pick in the space with plenty of growth runway ahead.
On the date of publication, Marie Brodbeck held shares in BAE. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.