A year ago, the outlook was unclear for some of the hottest defense stocks. The U.S. had just pulled its troops out of Afghanistan, and analysts were pointing to a potential period of isolationism. It appeared major powers such as the U.S. might turn their focus inward for a while and withdraw from the global stage.
However, Russia’s surprise invasion of Ukraine flipped everything on its head. That move made it impossible for the U.S. and its European allies to ignore their military budgets. Major powers such as Germany and Japan were forced to step up their defense spending to deter Russia and also head off potential future threats such as a possible geopolitical conflict in Taiwan. All this is to say that the situation has changed for defense stocks. Now, the industry can anticipate at least a few years of rising orders and increasing backlog as major countries rebuild and modernize their military power in the wake of the new geopolitical threats which have emerged to start the 2020s.
As if that weren’t enough, there’s one more element to watch closely. The U.S. created its Space Force in 2019 to oversee defense efforts in space including maintaining GPS, communications satellites, spaceplanes, and the country’s early missile warning defense system among other functions. The expansion of space-based operations adds more upside for defense stocks.
Lockheed Martin (LMT)
When investing in defense stocks, it makes sense to start with Lockheed Martin (NYSE:LMT). The company is one of the largest defense contractors in the world. It is known for its fighter jets. However, the company is also a leader in hypersonics, electronic warfare, and space and satellite systems in addition to its jets.
LMT stock is a one-stop shop for the defense industry since it has a footprint in so many different areas of the industry. Regardless of what sorts of wars or weapons systems prevail in the future, Lockheed Martin is likely to be a big part of the picture.
Lockheed Martin shares are up 40% over the past year. That might lead investors to think that shares must be expensive after such a run-up. Remarkably enough, however, LMT stock is still only selling for 20 times forward earnings. That’s hardly a high price, particularly given the improving outlook for fighter jet sales given the geopolitical developments that we’ve seen this year. The company is also a solid dividend growth story. Shares yield 2.5% today and Lockheed Martin regularly gives its shareholders sizable dividend increases.
Raytheon (NYSE:RTX), like Lockheed Martin, is another broadly diversified large defense contractor. It has operations spanning aerospace, jet engines, cybersecurity solutions, and a variety of other fields.
However, the company’s missile program has arguably gotten the most attention in 2022. The company has secured a number of new and expanded orders for its National Advanced Surface-to-Air Missile System (NASAMS) this year. The U.S. has transferred many of these systems to Ukraine to defend its airspace against Russian aggression.
Usage has been so heavy that the U.S. has depleted much of its supply of missiles. That has led to reorders, and Raytheon is gearing up for additional production. Raytheon just secured a new $1.2 billion surface-to-air missile order earlier this month to help with operations in Ukraine.
General Dynamics (GD)
General Dynamics (NYSE:GD) is another large defense contractor that oversees a wide range of defense products and solutions. The company’s calling card is its Columbia-class submarines. These allow the United States to project power around the world while protecting key allies. The submarine program has become increasingly important now that tensions are rising between China and Taiwan. If things escalate there, the U.S. Navy will play a key role in any potential conflicts in that sphere.
The company is also a leader in information technology for governments and militaries. For one example, look at NATO. General Dynamics won the contract to upgrade the defense organization’s formerly antiquated information technology systems. Those improved capabilities came into use in 2022 as NATO played a more active role in Europe following Russia’s invasion of Ukraine.
General Dynamics is not a pureplay defense stock. That’s because the company generates around a quarter of its profits from its Gulfstream business jet division. That adds some uncertainty to the outlook, particularly as the economy may be heading toward a recession. However, General Dynamics has a strong overall market position, and shares are reasonably priced heading into 2023.
BWX Technologies (BWXT)
Following up on General Dynamics, there is BWX Technologies (NYSE:BWXT). The company is a one-stop shop for all things nuclear. It makes commercial nuclear fuel, products for nuclear-based medical solutions, and various parts and components for nuclear submarines.
BWX helped design and manufacture components for the USS Nautilus, which was the world’s first nuclear-powered submarine. Decades later, BWX remains a leader in the nuclear submarine field. Its reactors help power various U.S. submarines and aircraft carriers.
Nuclear-powered ships are a vital asset given the current geopolitical landscape. Nuclear gives the Navy the ability to have ships run for months without having to return to port to refuel. This allows the United States more flexibility as it meets potential emerging challenges near Russia, China, and the Middle East.
There’s more to BWX than just the naval business as well. Nuclear power appears to be back on the upswing. The nuclear power industry has gotten several wins, such as being included in a relief package to help plants with financial issues. With Russia’s invasion this year, energy security has become a more pressing concern. Nuclear power could serve as an ideal “bridge” solution between fossil fuels and full-on wind and solar deployments. In any case, BWXT stock has rallied this year despite the bear market. Even with shares near 52-week highs, however, they still go for a reasonable 19 times forward earnings.
CAE Inc. (CAE)
For another angle at the defense industry, consider CAE (NYSE:CAE). The company produces software and simulation systems to help train airplane pilots, along with similar software for the healthcare industry to help doctors and surgeons practice various medical procedures.
The aviation side has multiple tailwinds going forward. On the commercial side, there is a historic pilot shortage. This comes as many pilots retired early during the Covid-19 pandemic. Since then, demand for commercial travel has come roaring back, leaving the airlines facing a big shortfall in capable pilots. CAE can help fill the gap with its pilot training programs. And there’s the defense side. Look for the air forces of both the U.S. and various allies to turn to CAE to help bolster their qualified pilot pools given the rise in global unrest this year. CAE has won contracts with the likes of the German Air Force and Australian Navy this year to help train pilots and sailors.
Northrop Grumman (NOC)
Northrop Grumman (NYSE:NOC) is a large, diversified defense contractor. The company is well-positioned with multiple programs which should benefit from the current increase in defense spending.
The company’s ground-based deterrence system is part of the nuclear triad, helping to ensure that other nations do not launch nuclear strikes. It helps replace the Minuteman intercontinental ballistic missile (ICBM) system, which had been in service for more than 50 years. That goes to show the sort of long duration of revenues that companies can earn on their military platforms once they go live.
And there’s more to Northrop Grumman. The company is developing a next-generation bomber plane that should have a similarly long life.
Perhaps most excitingly, Northrop Grumman is a leader in the emerging space industry. It serves almost all facets of the industry. It helps power NASA missions, works with communications satellites, and is involved in space security efforts as well. To that point, Northrop was part of the team that powered the NASA Orion vehicle, which had just recently completed a successful lunar mission.
To round out the list, there’s the company with arguably the most direct catalyst as it pertains to the war in Ukraine. That would be AeroVironment (NASDAQ:AVAV).
AeroVironment is a specialist in unmanned aircraft systems (UAS). The company has two primary offerings. It makes UAS vehicles that allow an army to get superior knowledge of what’s going on in an enemy battlefield or region. AeroVironment’s vehicles provide the user with tactical intelligence, surveillance, and reconnaissance of an area without putting human lives at risk.
The company also makes its Switchblade tactical missile system. These drones allow the United States and its allies to operate their missile units more efficiently than ever before. AeroVironment is proud of its efforts to help the Ukrainian resistance, stating that: “Our loitering missiles and UAS give Ukraine an unfair advantage.” When historians look back at why the war went so much better for Ukraine than initially expected, AeroVironment may play a key role in that recounting.
The outlook for AeroVironment is strong. The company’s unmanned vehicles have been particularly useful in the Ukraine theater as the west tries to avoid putting any direct boots on the ground. AeroVironment’s solutions have helped Ukraine fight without provoking Russia to further escalation. On top of that, look for more orders from the U.S. and its allies going forward as countries build their deterrent forces to try to dissuade bad actors from making invasions in the future.
On the date of publication, Ian Bezek held a long position in BWXT, RTX, and LMT stock. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.