The Big Guns in Defense

09/08/2015 7:00 am EST

Focus: STOCKS

Stephen Leeb

Founder and Research Chairman, Leeb Group

If you don’t own at least one of the four major defense contractors on our buy list, your outlook on the world may be far sunnier than ours, suggests growth stock expert Stephen Leeb, editor of The Complete Investor.

Not that there’s anything wrong with optimism. But in this case, it could hurt your investment returns.

The four major defense contractors are General Dynamics (GD), Lockheed Martin (LMT), Northrop Grumman (NOC), and Raytheon (RTN).

The US can’t afford to let its defense capabilities slide, not given mounting
signs that China’s military is making unexpectedly rapid gains.

Fiscal hawks notwithstanding, we expect US defense spending will burgeon, benefiting all the major defense contractors.

All of them have substantial free cash flow. They’ve used their free cash mostly to buy back shares and/or raise dividends, though both Raytheon and
Lockheed recently made cyber acquisitions, which we view favorably.

Lockheed, as the largest company, is assured of a major role in contracts for stealth fighters, missiles, and most big defense programs.

It has something to prove given that its F-35—currently the most advanced fighter—has been a disappointment.

We doubt the US will tamely cede the skies to China’s J-20 plane, making massive spending on air fighters likely.

The same goes for missiles, too, where Raytheon likely has the edge. Indeed, among the four big defense firms, our favorite is Raytheon.

One reason these stocks tend to travel together is that major programs typically involve a winning contractor that gives the losing bidders significant roles as subcontractors.

General Dynamics is the least likely to benefit from this because of its greater focus on non-government business. But it’s also the leading manufacturer of submarines, a pillar of the US Navy.

A final point is that countries throughout the world, not just the big guys like the US, and China, and Russia, are interested in defense and military capabilities.

That’s why in the past five years, sales to foreign countries have been in a steady uptrend, rising from about 15% of total sales to nearly 25%, with Raytheon and Lockheed leading the way.

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