Tuesday, September 21, 2010

The Gods of War

Only three things are guaranteed in life: Death, Taxes, and Warfare. No matter how barbaric, no matter how illogical, no matter what party is in office, America is perpetually at war. For the last century, there has not been even one decade where we were not involved in a major conflict, building up for a major conflict, or engaging in covert warfare. This is not meant to be a political article. It is not meant to open a debate if war is right or wrong. I am simply stating the facts. War is an extension of policy that America is willing to utilize. Take a look at the American Defense Spending for the last 20 years:

If this was a stock chart any investor would be chomping at the bit to buy into this company. Yet with Obama in office, the Iraq war winding down and the Afghanistan war filled with uncertainty, the Aerospace and Defense sector has been pummeled. Couple this with an unsustainable budget deficit and threats of austerity, high quality defense names are hemorrhaging market cap.

I believe these fears are overdone and the long term outlook for Lockheed Martin (LMT), Raytheon (RTN) and Northrop Grumman Corporation (NOC) remain strong. These are strong companies, with a wide moat due to a high barrier to entry, whose stock prices have been unfairly punished.

A few reasons the defense sector is being pummeled.

We are pulling out of Iraq: Allow me to channel Nostradamus ‘There will be conflict in the Middle East’. Be it Iran, Israel, Pakistan, Iraq, Afghanistan, Turkey, Lebanon, Egypt, etc…. there is going to be another major conflict and these companies will benefit from the destruction.

The Changing Face of Warfare: Warfare has changed from tanks and fighter jets to IED’s and terrorism. For the most part, this does not fall into LMT, RTN or NOC sweet spot. However, it would be foolish for America to abandon investment in conventional warfare. As sure as the sun rises, there will be another great conflict that is fought between opposing forces rather than insurgencies.

The Democratic Revolution: When the Dems swept the House, the Senate and eventually the Presidency, the defense sector almost immediately sold off. This is a knee jerk reaction that we see in all election cycles. But let’s be honest, this is shaping up to be a very short term revolution for the Democrats. A swing in the House and Senate will add back to the irrational sell off from the previous election cycle.

Let’s take a closer look at the fundamentals of these companies:

Current Last Sale (CLS)
$ 6.92
$ 5.00
$ 7.65
Annualized Dividend
Dividend Yield

These companies are trading at very low valuations, currently yielding greater than 3% and are hovering around their 52 week lows. I will concede that there are legitimate headwinds to these companies- some of which I outlined above- but these equities are entering the value zone. I believe the dividends are moderately secure and will create a safety net for the patient investors. There has been a recent rally in the sector, so I am holding off initiating a position in any of these names. I would start nibbling at RTN under $44, LMT under $69 and NOC around $59. For those that believe in the Greenblat Investment screen- these companies maintain high rankings on the S&P Index.

All the best,


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