Defense companies get the bulk of their revenue from one customer -- the U.S. government. Fortunately, that customer has deep pockets and a long history of paying its bills. The federal government’s stability gives defense companies and investors some predictability when it comes to managing cash and projecting growth.
Companies in the defense sector offer a wide range of products and services to their main customer, and some are better investments than others. Here's what you need to know about investing in the defense sector and how to pick where your money should go.
Top defense stocks
Top 6 defense stocks to buy in 2024
| Company | Defense Focus |
|---|---|
| Lockheed Martin (NYSE:LMT) | Aviation, space, missiles |
| Boeing (NYSE:BA) | Aircraft, space, helicopters |
| Northrop Grumman (NYSE:NOC) | Nuclear efforts, bombers, space |
| General Dynamics (NYSE:GD) | Shipbuilding, defense IT, tanks |
| RTX (NYSE:RTX) | Electronics, missiles, aerospace components |
| Leidos Holdings (NYSE:LDOS) | Defense IT, space |
Let's look closer at these standout companies.
1. Lockheed Martin
Lockheed Martin is the world's largest defense company and the U.S. government's biggest contractor. It's also the lead contractor on the F-35 Joint Strike Fighter, the world's most expensive airplane.
Lockheed's legendary Skunk Works research facility in California is world-renowned. The company has leveraged its research muscle to become a leader in advanced fighter planes, high-tech missiles, and cutting-edge electronics.
2. Boeing
Boeing is best known for its commercial airplanes, but its defense business is large enough to rank among the industry's titans. Boeing makes several aircraft and helicopters for the Pentagon and is involved in space pursuits. The company's defense business has also branched out into autonomous submarines and other products.
Boeing has been a tough stock to own over the past year due to issues stemming from its commercial side, but the company remains an important vendor to the U.S. government.
3. Northrop Grumman
Northrop Grumman is responsible for stealth bombers and has a large space portfolio. The company is closely tied to the nuclear triad -- a combination of nuclear missiles, bombers, and submarines able to strike back if the nation is attacked.
4. General Dynamics
General Dynamics is one of two primary military shipbuilders and has a portfolio of tanks and land vehicles, making it one of the go-to vendors for the U.S. Army. General Dynamics also has one of the largest defense-focused IT and services businesses, giving it some revenue stability at times when the Pentagon cuts back on equipment purchases.
5. RTX
RTX, formerly Raytheon Technologies, doesn't make warships or fighters. However, it does have a role in a wide range of important military platforms led by other contractors. It is the product of the 2020 merger between Raytheon, a defense electronics and missile specialist, and United Technologies, which makes aircraft engines and various other aerospace parts.
6. Leidos Holdings
Leidos Holdings is the largest government information technology (IT) company. It has also actively expanded into hardware, providing the electronics and brains for autonomous ships and building a strong portfolio of classified research capabilities geared for the intelligence and space communities.
Defense ETFs
Defense ETFs
If you are bullish on defense but would rather not choose among individual companies, you can buy shares in one or more exchange-traded funds (ETFs) that cover the sector. Three primary ETFs are focused on defense:
- Invesco Aerospace & Defense (NYSE:PPA)
- SPDR S&P Aerospace & Defense (NYSE:XAR)
- iShares U.S. Aerospace & Defense (BATS:ITA)
Electronic defense
Defense goes electric
For most of its history, the defense industry's primary expertise was metal-bending. Only a few companies on Earth could build massive battleships, bombers, and tanks.
But in defense, as in the rest of the world, value is increasingly going not to the companies forging the steel but to the ones providing the brains that go inside it. Defense electronics and cybersecurity are growing portions of almost every company's portfolio. It's where a lot of the internal investment is going right now.
Defense IT also remains a priority, with vendors scrambling to provide the Pentagon with secure networks and data-rich communications systems.
Effect of conflict
Will conflict move defense stocks?
Pay attention to the nightly headlines, and it becomes clear that we are in a period of global unrest. The Russian invasion of Ukraine is more than two years old, and renewed armed conflict between Israel and Hamas is threatening to destabilize the entire Middle East. The battles have reignited simmering Cold War-era tensions and have provided a horrific reminder of the importance of a strong, modernized military.
Defense stocks tend to move higher at the onset of a new conflict but rarely sustain those gains. Investors should understand that defense projects tend to have multiyear timetables that don't lend themselves to a quick revenue surge, even when demand is on the upswing.
Large defense contractors generate much better margins on research and development (R&D) into new advanced weapons systems than from selling one-off missiles or ammunition. If the U.S. government were to deemphasize research to fund active operations, the conflicts in Europe and the Middle East could actually negatively affect defense stocks. However, given the importance of research, that seems unlikely.
Longer-term, the impact could be more substantial. These conflicts are likely to add to defense sales in the years to come through the replenishment of weapons sent to Ukraine and Israel and as U.S. allies in Europe and elsewhere look to strengthen their military muscle.
Investing in defense
Investing in defense companies
The defense sector is more than just weapons used on land, sea, and air. It's defined more broadly as companies primarily catering to the Pentagon or other government agencies.
The list includes weapons makers but also service companies that run IT networks, manage inventories, and perform other tasks for government agencies. Defense company strengths include:
- The ability to navigate the Byzantine government procurement process and have thousands of employees with the security clearances necessary to do defense work
- Predictable revenues driven largely by the government's annual provision of a five-year outlook of planned purchases
- Healthy dividend payouts, due in part to some defense companies' R&D being funded by the government -- freeing up cash that can be returned to shareholders
Finding the best
How to find the best defense stocks
The defense sector tends to be a stable group of companies with a few failures and a few standouts. Here are some tips for evaluating individual defense companies.
Listen to the customer
The Pentagon has an insatiable appetite for new equipment. But with aircraft carriers costing more than $10 billion and F-35 fighters priced at $110 million or more, the government can only buy so much. To figure out the likely winners and losers, pay attention to the budgeting process.
Early in the year, the Pentagon sends a funding request to Congress, which then holds hearings to discuss priorities and make final allocation choices throughout the spring and into the summer. An investor need not hang on every word. However, the budget request, available on the Pentagon's website, and commentary elsewhere can provide clues about which billion-dollar programs are administration priorities.
Follow the numbers
Companies often highlight massive contract awards in press releases ithout explaining that those big dollar figures are often spread out over many years and may depend on Congress approving the funds. Pay attention to these metrics when evaluating defense stocks:
- Free cash flow: This is important for any business, but free cash flow can vary for defense contractors based on whether their projects are new or well established. Companies often spend more in the early stages of a production contract, temporarily depressing cash flow.
- Corporate backlogs: Investors should pay close attention to corporate backlogs, which are future contracts that have been awarded but not yet executed. How much of a backlog has been funded and how much must go through the congressional budgeting process can vary greatly.
- Book-to-bill ratio: This metric compares the value of orders received in a given quarter to the amount billed and indicates a company's growth potential. A growing company should have a book-to-bill ratio of at least 1.0, implying that orders for future products are being booked at a rate that equals or exceeds what is being shipped today.
Defense companies know investors are focused on these metrics and typically provide the relevant information in quarterly earnings reports or conference calls.
Related investing topics
Are defense stocks right for your portfolio?
Defense companies manufacture lethal products and can be involved in supporting clandestine operations or intelligence-gathering that some find unsettling. Some investors don't want to support those activities and may want to avoid becoming shareholders of defense stocks.
Like many industrials, defense stocks tend to be more plodding than high-flying technology or biotech stocks. But that also means they are less volatile than some sectors. Defense stocks are best suited for income-oriented investors seeking steady growth and rising dividends rather than immense valuation increases.
FAQ
Best defense stocks: FAQ
What is the top defense stock?
Lockheed Martin is both the largest pure-play defense company and the one with the most revenue diversity in terms of exposure to different agencies and platforms. Although it doesn't always outperform in the near term, it is the top choice among defense stocks for long-term-focused investors.
Are defense stocks a good buy?
Defense stock valuations tend to be tied to government spending, which can mean periods of underperformance. However, over the long run, defense stocks offer growth rates higher than inflation and steady dividend income, making them a solid choice for investors seeking stability and income in their portfolios.
Do defense stocks rise during war?
Defense stocks tend to jump higher on headlines of a new military conflict but give up some of those gains in the following months. Even if a conflict creates a higher demand for defense equipment, orders take time to materialize and even longer to fulfill. For that reason, military conflict is not typically an immediate boost to results.
