Two Favorites for Global Defense

12/20/2016 7:00 am EST

Focus: STOCKS

Yiannis Mostrous

Editor, The Capitalist Times

Geopolitical developments will increasingly shape how investors allocate capital. More specifically, the world may be entering a period when countries steadily increase military spending, cautions global expert Yiannis Mostrous, editor of Capitalist Times.

The defense industry’s financial performance historically exhibits limited correlation to the rest of the economy because demand for its products doesn’t depend on the consumer.

And if the new administration lives up to its promises and increases the defense budget, current valuations in the industry should be sustainable.

But investors should remember that the new administration’s first proposed budget will be for 2018; as such, be patient and focus on bottom-up analysis to maximize your returns. Here are two of our best ideas to play this trend.

General Dynamics Corp (GD) is our favorite US-based defense stock for longer-term investors due to its exposure to the steadily growing market for private jets.

Although some investors dismiss GD for this very reason, the Gulfstream business balances the company’s revenue. It also doesn’t hurt that order flow for jets remains solid and the division has built a healthy backlog.

We also like the company’s strong balance sheet and manageable long-term pension liabilities. General Dynamics has expanded its operating profit margins since 2013, a trend that should continue in coming years.

The company also boasts the biggest stock repurchase program in the industry and has the best and most shareholder-friendly management teams among its peers.

Though not widely recognized, CAE (CAE) is one of the world’s leading providers of training services and simulation technology for the defense, aviation and health-care markets.

About 35 percent of revenue comes from the US, with Europe accounting for 25 percent.

The Quebec-based company’s defense and security division continues to grow at a rapid clip and accounts for about 40 percent of the firm’s revenue.

This segment operates more than 80 sites in 35 countries, and its military aircraft simulators account for about 22 percent of the global installed base.

CAE's market leadership and high-quality products should enable it to win a fair number of new contract opportunities. The timing of these awards is uncertain, but the first announcements could be made over the next four to six months.

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