Over the last month, there’s been an increase in geopolitical tensions. The US has been pulling out of Afghanistan which has been a difficult and complicated affair even before the tragic terrorist attack at the airport. Some analysts fear that the country could once again become a safe haven for extremists.

In addition to this, there are signs of increasing Chinese aggression in terms of its provocations towards Taiwan and patrols around the Philippines and Japanese-controlled islands. On top of this, there are reports that North Korea has restarted its nuclear reactor in Yongpyong. 

Geopolitics and financial markets have always been intertwined. After 9/11, the defense sector was one of the best-performing sectors over the following decade. In the last couple of years, defense stocks have underperformed but this could change especially with recent catalysts. Therefore, investors should look to buy high-quality defense stocks like Lockheed Martin (LMT), Northrop Grumman (NOC), General Dynamics (GD), and OSI Systems (OSIS).  

Lockheed Martin (LMT) 

LMT is one of the top defense companies in the world. It operates through four segments: Aeronautics, Missiles and Fire Control, Rotary and Mission Systems, and Space. Currently, its largest revenue source is Aeronautics due to the F-35, however, its largest growth driver is its Space division. 

While the coronavirus temporarily depressed revenues, the company has been on a strong run over the past few months as it’s inked a variety of deals providing equipment and services to countries all over the world including for its Space Infrared System and tactical Missile and Fire Control products. 

LMT’s stock has been range-bound since 2018. However, over this time period, revenues and earnings have continued to compound, and it has increased dividends. Revenues have increased from $50 billion to $66 billion. EPS has gone from $8 per share to $24 per share. And, dividends have grown from $6.75 to $10.09 per share. 

This has made LMT quite attractive from a valuation perspective with a price-to-earnings ratio of 15 which is significantly cheaper than the S&P 500. Further, we are seeing growth expectations diminish as long-term rates have plunged over the past few months. This makes a defense company like LMT with stable revenues and growing dividends more attractive.   

It’s no surprise that LMT has an overall B rating, which equates to a Buy in the POWR Ratings system. LMT also has a B for Quality. This is consistent with Wall Street’s view of the stock as it has a consensus price target of $424 which is 17% above its current price. Further, no analysts have a sell rating, while 6 have a Buy rating on it. To see more of LMT’s POWR Ratings, click here.

Northrop Grumman (NOC)

NOC is a defense contractor with segments in aeronautics, mission systems, defense services, and space systems. Like LMT, NOC has underperformed in the last couple of years. Since 2018, shares are up 4%, while the S&P 500 is up 58%. 

This is despite interest rates trending lower, and NOC continuing to compound at an impressive rate. Given that its business continues to improve, NOC shares should be bought as it’s quite attractive with a price-to-earnings ratio of 14 and an above-average dividend yield of 1.7%. Further, defense spending in 2021 and 2022 is expected to grow marginally despite concerns that a Democratic administration would choose other priorities. 

Like LMT, NOC has a growth component given its exposure to the space industry. Its subsidiary, SpaceLogistics LLC, completed the docking of the Mission Extension Vehicle-2 to the Intelsat 10-02 commercial communications satellite to deliver life-extension services. And, NOC is one of the leading companies in extending and servicing satellites that are in orbit. 

Its latest earnings report demonstrates that its underlying business continues to grow and compound as it topped expectations and raised its forecast for the full year. It delivered $6.42 per share in earnings, beating expectations of $5.75 per share. This marked its fourth straight quarter of beating earnings estimates. Revenue at $9.2 billion also topped expectations of $8.9 billion. It also increased its full-year EPS forecast to $24.80 per share from $24 per share previously. 

NOC’s combination of growth and value is certainly enticing. Thus, it’s not surprising that NOC has an overall B rating, which represents a Buy. The POWR Ratings are calculated considering 118 different factors, with each factor weighted to an optimal degree. B-rated stocks have an average annual performance of 19.7% which compares favorably to the S&P 500’s annual performance of 7.1%. To see more of NOC’s POWR Ratings, click here. 

General Dynamics (GD)

GD is an aerospace and defense company headquartered in Virginia with worldwide operations. The company has four segments: Aerospace, Marine Systems, Combat Systems, and Technologies. 

It sells a wide range of products including Gulfstream aircraft, nuclear-powered submarines, drones, and ships. The company also has a growing cybersecurity division for governments and militaries. Like LMT and NOC, GD has been an underperformer over the last couple of years. Yet, this seems to be more of a market rotation rather than a reflection of a deteriorating business. 

In its last quarter, the company reported 7% revenue growth and topped EPS expectations by a meaningful amount. Equally important, its order backlog for Gulfstream jets grew by 16%. As a result, the company was able to raise its full-year outlook for earnings and revenue which should continue to drive the stock higher. Next quarter, earnings and revenue are forecast to increase by 9% and 4%, respectively. 

GD is also attractive from a valuation perspective with its forward P/E ratio of 16 which is cheaper than the S&P 500’s forward P/E of 22.5. Adding to its appeal is its 2.4% dividend yield which is quite appealing given the shaky growth outlook. 

GD’s strong fundamentals are reflected in its POWR Ratings. The stock has an overall B rating, which equates to Buy in our proprietary rating system. The POWR Ratings also evaluate stocks by components to give additional insight. For Sentiment, GD is graded a B which is consistent with the analyst community’s bullish outlook on the stock. To see more of GD’s POWR Ratings, click here. 

OSI Systems (OSIS)

OSIS designs, manufactures, and sells electronics systems and components. The company’s customers are primarily found in the healthcare, defense, and aerospace industries. The company operates through three segments: Security, Healthcare, Optoelectronics, and Manufacturing. The company is mostly known for its airport security equipment and full-body scanners.

The company is in the midst of an earnings boom as its EPS has doubled over the last 3 years. Further, this trend is likely to continue given that its order backlog increased by 23% in the last quarter to $1.1 billion. 

This earnings report markets its fourth straight quarter of beating earnings expectations as it reported $1.54 per share beating expectations of $1.45 per share. Revenue also topped consensus expectations by a meaty 7%. Following this report, 2022 EPS estimates have been hiked by about 7%. 

OSIS has an overall B rating, which equates to a Buy in our POWR Ratings system. It’s also unique in having an A for Growth and Value as these tend to typically be inversely correlated. OSIS’ value grade is not surprising given that it has a price to free cash flow ratio of 14 which puts it in the top 10% of all stocks. To see more of OSIS’ POWR Ratings, click here.

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This article was written by Jaimini Desai, Chief Growth Strategist for StockNews.com.  Jaimini has been dialed into the hottest trends in investing:

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LMT shares were trading at $359.00 per share on Tuesday morning, down $3.05 (-0.84%). Year-to-date, LMT has gained 2.60%, versus a 21.58% rise in the benchmark S&P 500 index during the same period.

Jaimini Desai has been a financial writer and reporter for nearly a decade. His goal is to help readers identify risks and opportunities in the markets. He is the Chief Growth Strategist for StockNews.com and the editor of POWR Growth newsletter. Learn more about Jaimini’s background, along with links to his most recent articles.

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