Ben Reynolds — a leading expert on income and value investing — recently reviewed the defense sector; in his Sure Dividend, the advisor offers a look at his three top picks in the space.

L3Harris Technologies (LHX) is a $38 billion market cap aerospace and defense business that is the result of a merger between L3 Technologies and Harris Corporation.

As a prime U.S. defense contractor, L3Harris Technologies has an entrenched position in many of its end markets. As a result, it benefits from extensive regulatory knowledge, a significant intellectual property portfolio, and deep relationships within the Department of Defense that make it very challenging for a new entrant to compete with them for contracts.

Additionally, the fact that most of its revenues come from the government makes it quite recession resistant. During the Great Financial Crisis, L3Harris Technologies’ combined companies continued to raise their dividend each year.

Over the past decade, the combined L3Harris Technologies companies grew earnings-per-share by a 9.7% average yearly rate.

Moving forward we anticipate 10% annual EPS growth, with many of the same factors contributing to this thesis. We expect L3Harris Technologies to generate earnings-per-share of $12.80 in 2021. Based on this, the stock is currently trading at a price-to-earnings ratio (P/E) of 14.4.

Our fair value estimate is a P/E of 16.0, which means expansion of the P/E multiple could add 2.2% per year to annual returns. When combined with the 10% expected growth rate and 2.2% dividend yield, total return potential comes to 14.2% per year over the next five years.

Lockheed Martin Corp. (LMT) is the world’s largest defense company. Its backlog is approximately $147.1 billion driven by increases in Aeronautics, Missiles and Fire Control, and Rotary and Mission Systems, but offset by a decline in Space. For 2021 the company expects revenue of $67.1 to $68.5 billion and earnings-per-share of $26.00 to $26.30.

Lockheed Martin is an entrenched military contractor. It produces aircraft and other platforms that serve as the backbone for the U.S. military and other militaries around the world.

This leads to a competitive advantage as any new technologies would have to significantly outperform existing platforms. These platforms have decades long life cycles and Lockheed Martin has the expertise and experience to perform sustainment and modernization.

In addition, these characteristics lead to a good degree of recession resistance. Moving forward we expect 8% annual EPS growth, with help from many of the same factors. We expect Lockheed Martin to generate earnings-per-share of $26.15 in 2021. Based on this, the stock is currently trading at a P/E of 12.9.

Our fair value estimate is a P/E of 16.0, which means expansion of the P/E multiple could increase returns by 4.3% per year. When combined with the 8% anticipated EPS growth rate and 3.1% starting yield, total return potential comes to 15.0% per year over the next half decade.

Northrop Grumman (NOC) is a $50 billion market cap aerospace and defense business. The company makes the B-2 Spirit stealth bomber, E-2D Advanced Hawkeye and E-8C JSTARS and provide content on the F-35 Lightening II and F/A-18 Super Hornet.

The company won $52.9 billion in contracts in 2020 with a book-to-bill ratio of 1.4 and total backlog increased 25% to $81.0 billion at year end.

As a prime U.S. defense contractor, Northrop Grumman has an entrenched position in many of its end markets. Of note are the B-2, B-21, E-2D, E-8C, Global Hawk and Triton platforms. These platforms have decades-long life cycles and Northrop Grumman has the expertise to perform sustainment and modernization.

These characteristics allow for a good deal of ballast in lesser times. Moving forward we anticipate 8% annual EPS growth, with many of the same factors contributing to this thesis. We expected Northrop Grumman to generate earnings-per-share of $23.40 in 2021. Based on this, the stock is currently trading at a P/E of 12.7.

Our fair value estimate is a P/E of 15.0, which means expansion of the P/E multiple could add 3.4% per year to annual returns. When combined with the 8.0% expected growth rate and 1.9% dividend yield, total return potential comes to 13.2% per year over the next five years.

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