Under-the-Radar Defense Duo

12/14/2015 7:00 am EST

Focus: STOCKS

Marshall Hargrave

Contributing Editor, Wyatt Investment Research

The recent terrorist attacks have sent fear across much of the market. It's a time of heightened security as we head into the holiday season, asserts Marshall Hargrave in Daily Profit.

The most obvious trade has been buying defense contractors, which will benefit from increased global turmoil. However, the conventional defense stocks are already trading at 52-week highs.

But there could be one part of the market that investors have been overlooking: government services. So while the major defense contractors will benefit from an increase in demand in tanks and fighter jets, there are a handful of companies doing behind the scenes work.

Booz Allen Hamilton (BAH) is a consulting firm that offers technology and engineering services to the US Department of Defense—particularly the National Security Agency—and the Department of Homeland Security.

A quarter of its revenues are generated from such intelligence work. As the US government boosts its global surveillance and creates partnerships for information sharing with other countries, the likes of Booze Allen will be a big winner.

Booz Allen already has a strong backlog, which is approaching multi-year highs and means more robust growth going forward. Earnings are expected to grow at an annualized 8.5% rate over the next five years, well above many peers. It's also in the process of working out a two-year defense budget that will further juice its backlog.

Shares are offering a 1.7% dividend yield and the company is generating a healthy 17% return on invested capital.

ManTech International (MANT) is another consulting firm focused on providing information technology services to the US government. It will benefit from US efforts to boost its intelligence presence in the Middle East.

Shares are still 35% off their multi-year highs back in 2009, given the decline in budgets for overseas operations, including the pullback from Afghanistan by the US government. However, this could be precisely what makes ManTech worth buying today.

The worries over US budget sequestration have pressured ManTech and others, but they are finding stabilization in their revenue streams of late and could get a boost from future US involvement in the Middle East.

Beyond that, ManTech also has a presence in the cyber-security and healthcare consulting markets. Shares offer a 2.7% dividend yield. It's also worth noting that ManTech has a debt-free balance sheet.

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