For Bigger Defense Stock Profits, Think Small
One of the most reliable and proven ways to build wealth over the long haul is to place investment capital in high-momentum trends. President Trump has promised to massively increase military spending and to also pursue a more assertive foreign policy. That adds up to filled coffers for America’s aerospace/defense firms.
But here’s an angle that many traders are ignoring: look beyond the usual mega-cap suspects and consider little-known, small-cap defense stocks. Below, I highlight a small defense stock that’s poised for outsized growth and trades at an appealing valuation.
Linda McDonough, chief investment strategist of Profit Catalyst Alert, explains that if you want to really cash in on the coming defense boom, you need to think small.
“Thanks to the monstrous size of many military budgets, most defense stocks are mega-caps — Goliaths so large they grow slowly. Yet small growth defense stocks exist.”
Blue skies ahead for defense…
Linda notes that defense spending “catapults upward in times of strife, settles into the trenches for brief periods of peace and then jets forward again as conflicts resume.”
Jim Pearce, chief investment strategist of Personal Finance, remarks that the transfer of power in Washington, DC always entails economic winners and losers. This time around, he says, defense contractors are among the biggest winners:
“Re-engineering how money flows among nations and between economic sectors has enormous consequences, something Trump intuitively understands, which is why trade reform is at the top of his agenda. Corporate CEOs also understand the ramifications of their industries getting pushed up (or down) the priority list…
One sector that probably won’t have to lobby for more dollars is the defense industry.”
But with large-cap stocks trading at frothy valuations in early 2017, small is a smart way to go. Smaller defense firms also confer another advantage: they’re tempting takeover targets for deep-pocketed blue chips looking to acquire and integrate new proprietary technologies that can foster organic innovation.
Our technology experts at Breakthrough Tech Profits call this process “innogration” and they make it their mission to spot likely takeover targets that will richly reward investors when bigger companies show up as M&A suitors.
Jim Fink, chief investment strategist of Options For Income and Velocity Trader, hammers home the case: “Small-capitalization stocks outperform all other types of stocks over the long term.”
The Pentagon’s funding trough…
Before we get to our small defense stock, let’s look at the big picture.
While Congress fights bitter ideological battles over programs with relatively small funding, the Pentagon continues to enjoy enormous largess. Don’t let anyone try to tell you that the U.S. military is lacking for funds. The U.S. military’s fiscal year 2016 budget reached $534.3 billion, an increase of $38.2 billion over the FY 2015 enacted budget of $496.1 billion. For fiscal 2017, the military budget should come in at about $582.70, a roughly 9% year-over-year increase.
You can leverage this permanent and growing pool money for multi-year profits. However, investors looking to make money in the aerospace/defense sector tend to fixate on the familiar names: Boeing (NYSE: BA), Lockheed Martin (NYSE: LMT), General Dynamics (NYSE: GD), Northrop Grumman (NYSE: NOC), and Honeywell International (NYSE: HON), to name a few of the biggest.
These are all solid investments, especially Honeywell because of its diversification and significant work in the civilian sector. Indeed, Honeywell is a long-time denizen of the PF Growth Portfolio. Since it was added to the portfolio on May 11, 2011, Honeywell has generated a total return of 122.58%.
However, these market caps are gigantic and expected boosts in defense spending are pushing up their valuations. For most of them, that means a limited upside.
Which brings us to the beauty of small caps. These companies historically outperform the broader market during economic recoveries. U.S. economic growth continues apace (albeit at a modest rate), a context that’s been manna over the past 12 months for smaller valuation companies.
The Goldilocks of defense…
With a market cap of $1.05 billion, Astronics (NSDQ: ATRO) is large enough to withstand market turmoil but small enough to provide market-beating appreciation. It’s a “Goldilocks” stock that occupies the sweet middle ground.
Astronics designs and manufactures products for the aerospace and defense industries around the world. It operates through two divisions, Aerospace and Test Systems.
The Aerospace division offers lighting and safety systems, electrical power generation, aircraft structures, avionics products, and other products.
The Test Systems division provides automatic test systems, such as communications and weapons test systems, and training and simulation devices to aircraft OEMs.
ATRO is a small-cap defense rocket ready to break out with double-digit gains. The company’s earnings growth over the next five years is projected to hit 7.75% on an annualized basis. The aerospace/defense sector has been on a tear lately, but ATRO’s trailing 12-month price-to-earnings ratio is about 17, compared to 21.4 for Boeing and 20.4 for Lockheed Martin and nearly 19 for the overall sector.
If you’re looking for reasonably valued growth in an overbought and risky market, this small cap fits the bill. Meanwhile, we’ll keep an eye on Astronics and let you know if it becomes a takeover target.
The yellow metal is showing its mettle…
I got this worried email yesterday from a reader:
“I was reading your article, ‘Global Domino Effect: Are You Ready?’ published on Feb. 6. It’s a bit of a scary read, by the way. You recommend that investors hedge at least 5%-10% of their portfolios in gold.
Would you consider GLD or GLDW to be good hedges that fit your thoughts? I’m a beginning investor and not in much gold right now and I’m trying to park some money in that area.” — Jason E.
Jason, it’s never my intention to scare readers. In fact, I disdain the fear-mongers in our business. By the same token, it’s unwise to bury our heads in the sand when genuine risks emerge.
A safe gold hedge suitable for novice investors is the SPDR Gold Shares ETF (NYSE: GLD), the largest gold exchange-traded fund backed by physical holdings of bullion. I’ve recommended this fund in recent issues.
A sibling and somewhat riskier fund, SPDR Long Dollar Gold Trust (NYSE: GLDW), made its market debut on January 30. GLDW is the first physically backed gold ETF with a currency hedge against a strong U.S. dollar. GLDW gains when gold prices spike and the value of the dollar increases. (Historically, a strengthening greenback weighs on gold prices.)
I’ve also recommended the high-quality gold miner Goldcorp (NYE: GG). Canada-based Goldcorp is on course for production growth and boasts extremely low operating costs, a combination that should boost profits as the price of gold rises this year as analysts expect.
The Investing Daily Mailbag
Got a question about defense stocks or gold? Drop me a line.
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I’d love to hear from you: email@example.com — John Persinos