Defense Stocks Set to Return Fire

10/22/2011 2:45 pm EST

Focus: STOCKS

Kelley Wright

Managing Editor, Investment Quality Trends

The beaten-down shares of big Pentagon contractors show plenty of offensive potential, as do several of the oil majors, says Kelley Wright of Investment Quality Trends in this exclusive interview with MoneyShow.com.

You were telling me that the high-dividend-paying, solid blue-chip companies that you track are really showing some interesting trends lately. Could you discuss them?

Yes, there are signs of life in the high-quality universe. What we have found since 1966 is that when our undervalued category is 17% or less of our overall universe, it has been coincident with major market tops.

Twice in the last eight weeks we got down to about 19% to 19.5% of our universe and—thankfully, conveniently for us—the market turned around and corrected. Now we’re probably about 34% to 35% in our undervalued category, and there are fantastic names.

So what about a market bottom, let’s say like from the end of 2008 to March of 2009, what percentage do you get up to around then?

Just as 17% gives us an idea we’re topping out, when we get to 70% to 75% undervalued, that’s been coincident with major market bottoms. On March 6, 2009, intraday, we hit 74% of our undervalued category…and then the rest is history.

So, looking at it just mathematically, we probably were a lot closer to a market top recently than we are to a market bottom now based on that statistic, right?

It’s probably true. I think we might have put in a good intermediate-term bottom for the time being.

Can you give us a couple of names that look pretty good right now?

You know there was a lot of talk going on in Washington, DC about the budget situation, and we have a supercommittee that’s going to make a lot of decisions.

The conventional wisdom on Wall Street is that one of the things that is going to be sacrificed will be the defense area. United Technologies (UTX) does have a defense component in it.

They make aircraft engines, don’t they?

They do, and Sikorsky helicopters and parts and things like that, but they also make elevators, and they make heating ventilation and cooling. They do green energy. So defense is not the straw that stirs their drink, but it’s a conglomerate and it’s part of it, and the market took the defense sector out and shot it.

Here is a company that has an A+ earnings and dividend quality ranking. They raise their dividend at least 10% a year on average, and they’ve done it forever. It’s trading around $68 or $69 [more like $75 due to our current rally—Editor], and by our measurements based on its current yield, it’s undervalued area is up to about $82.

Wow, so you think that’s deeply undervalued.

It’s a significant value in here. In the tech sector, Harris Communications (HRS) is another fantastic, A+ rated stock.

Do they have military exposure?

I think it’s just because it’s just a tech company and that got out of favor there for a few weeks, but they have a phenomenal history of raising the dividend significantly every year. A+ quality, excellent company, very undervalued. ConocoPhillips (COP), Chevron (CVX) …

Oh, the energy companies.

Occidental Petroleum (OXY), Exxon Mobil (XOM) are all great buys. Oil has rebounded a little bit, and even though the global economy will be slowing, the last time I looked it was still the major energy source, so all the oil majors show excellent value.

Any one of those in particular that you like?

Well, ConocoPhillips has the best yield, almost 4%. Chevron has got the most upside. We have an upside target of about $155 on it.

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