Last year, total military expenditure increased 3.7% on a year-on-year basis to $2.24 trillion. Further, military spending in Europe saw the steepest increase on a year-on-year basis in the last 30 years. This does not come as a surprise as geopolitical tensions escalate. Given several points of friction globally, buying and holding some of the best defense stocks is important.
Even with favorable industry tailwinds, defense stocks have not gone ballistic. However, a breakout rally seems impending as the order backlog swells for some of the top defense companies. Backlog growth will translate into higher revenue and free cash flows.
This column discusses three defense stocks to buy and forget. While two stocks represent well-established defense companies, another is an emerging defense stock that can deliver multibagger returns.
Lockheed Martin (LMT)
Lockheed Martin (NYSE:LMT) is among the best defense stocks to buy and hold. LMT stock trades at an attractive forward price-earnings ratio of 16.3 and offers a dividend yield of 2.86%. Given the industry tailwinds and positive business developments, I am bullish on a meaningful rally.
Among the business positives, Lockheed reported a record backlog of $158 billion as of Q2 2023. It’s likely that the backlog will continue to swell and provide clear cash flow visibility. For the current year, Lockheed has guided for free cash flow of $6.2 billion.
Another key catalyst is that Lockheed expects to return to growth in the coming quarters. As revenue growth accelerates, there is a strong case for re-rating.
Lockheed invested $700 million in research and development in Q2 2023. This implies annualized R&D spending of nearly $3 billion. Investment in next-generation defense technology will ensure robust growth.
Leonardo DRS (DRS)
Leonardo DRS (NASDAQ:DRS) is among the hidden-gem defense stocks to buy. Year-to-date, DRS stock has trended higher by 55%. However, I believe the positive momentum will be sustained on the back of robust defense spending.
Leonardo is a provider of defense products and technologies. This includes advanced sensing, network computing, force protection, and electrical power conversion and propulsion. As of Q2 2023, the company reported an order backlog of $4.4 billion.
Recently, the company successfully demonstrated its “On Board Vehicle Power” technology to the U.S. Army. As the product basket swells, the backlog is likely to increase. Additionally, defense spending will continue to increase in the U.S. and Europe. Leonardo is positioned to benefit as a leading defense technology player.
The company has also indicated potential mergers and acquisitions as a growth strategy. With a strong balance sheet, potential acquisitions can boost the growth outlook.
Northrop Grumman (NOC)
Northrop Grumman (NYSE:NOC) stock has remained sideways in the last 12 months. This is a good opportunity to accumulate the stock that trades at an attractive valuation. UBS recently initiated “Buy” coverage on the stock with a price target of $555, implying more than 10% upside from current levels of $490.
Coming to the fundamentals, there are two points to note. First, Northrop reported an order backlog of $78.8 billion as of Q2 2023. During the quarter, the order intake was robust at $10.9 billion. Northrop is positioned to accelerate growth and cash flows as the backlog swells.
Further, the company has guided for a free cash flow of $2 billion for 2023. This provides headroom for dividend growth and continued share repurchase. Additionally, based on annualized Q2 2023 numbers, Northrop will likely invest $2.4 billion in 2023 towards research and development. This is another factor that will help in accelerating long-term growth.
On the date of publication, Faisal Humayun did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.