The US has the highest military spending in the world. In 2021, the Pentagon spent a whopping $777.7 billion in defense. In contrast, China came second with a military budget of $209 billion. What’s more, military contracts tend to span several years and usually have long lead times. Coupled with the large military spending, defense contractors for the US government enjoy steady revenue streams, which attracts investors aplenty. Investors with an appetite for risk may bet on some of these individual companies’ stocks, while their risk-averse counterparts may opt to invest in the lower-risk defense ETFs instead.
Trends in the defense industry
Emphasis on technology
Since the World War era, most countries’ defense industries have been mainly concerned with building bigger, meaner machines of destruction. These included but were not limited to battleships, bombers, and tanks. Nowadays, with defense contractors building such things as autonomous missiles and self-driving submarines, emphasis has shifted to the brains behind these systems.
Electronics and IT systems are becoming a huge selling point for weapons. Therefore, investors should pay attention to all the innovative technologies that are coming out in the space, as this is what is setting the leading contractors apart.
US change in leadership
During his reign, former US President Donald Trump significantly increased the country’s military spending. When he was voted out of office in 2020, defense stocks suffered as investors expected the incumbent president to slash this budget. However, when Biden took office, the Pentagon budget in his first year remained largely unchanged. Now, the tide has changed, and with the emphasis being put on research and modernization, this budget may very well increase in the near future. This will see defense stocks stage impressive returns over the coming years.
Increased tension for warfare
The US and its allies are currently facing increased tension from the Russia-Ukraine conflict, as well as other different regions in the world. If any of these conflicts were to escalate into war, the Pentagon would spend much more on ammunition and various weapons systems. At face value, this seems like it would be extremely bullish for defense stocks and ETFs.
In an actual sense, however, most of these contractors’ revenue is obtained from research and the development of new weapons systems. Therefore, if their focus was shifted from this research to the continued production of ammunition, this would negatively affect their stocks. However, given the role research and development has played in winning previous wars, this is unlikely to be the situation even if war breaks out.
Defense stocks worth keeping tabs on
Lockheed Martin (LMT)
This is the largest defense contractor by revenue. In 2021, they reported a yearly yield of $67 billion. Notably, LMT was assigned a $400 billion dollar contract to produce the F-35 fighter jet. This has set the record as the most money the Pentagon has spent on a single program. Other than the US, the F-35 is also a fan favorite among many of its allies, and Lockheed has an order of 3,100 F-35s to fulfill by 2035. This will see them record a steady revenue over the coming years.
Lockheed also produces military helicopters, missiles, fire control systems, and hypersonic weapons. They also have space programs such as developing the Orion spacecraft for NASA.
Boeing
This is a company famed for its commercial jets. However, it also has substantial defense contracts, which accounted for $26.54 billion in revenue for the year 2021. It produces several aircraft for the Pentagon, such as the F/A-18 and F-15. In 2020, they were awarded a $23 billion contract to build an improved F-15, the F-15EX.
Boeing also produces the T-7 trainer jet, the MQ-25 drone, which is used for mid-air refueling, the KC-46 tanker, and the P-8, which is used for aerial surveillance. They also have space exploration contracts, such as the Space Launch System and the Starliner for ferrying astronauts to the ISS.
Northrop Grumman
In 2021, Northrop recorded a yearly revenue of $35.7 billion. The company was awarded a joint contract with Lockheed Martin to produce the F-35 fighter jet. It also manufactures drones like the Global Hawk. They recently acquired Orbital ATK, which has seen them venture into the space exploration field. Another notable project by Northrop is the B-21 stealth bomber. The Air Force has requested the production of 80 to 100 of these aircraft.
Defense ETFs worth investing in
Investing in a single company’s stock may yield impressive returns, but it may be too risky for some investors. To reduce their exposure, such investors would be better off betting on the lower-risk defense ETFs.
Below is a couple of them.
iShares US Aerospace and Defense (ITA)
With a total AUM of $2.5 billion, this ETF is a collection of all the top names in the defense industry. It tracks the Dow Jones index and contains stocks of companies like Boeing and Lockheed Martin. These are typically large, slow-growing companies, but they enjoy steady revenue due to their long-term government contracts. However, this could also be their Achilles heel, especially if for one reason or another, the defense budget is slashed drastically.
SPDR S&P Aerospace and Defense ETF (XAR)
This fund has a total AUM of $1.07 billion, and it contains stocks of 37 companies, among them Northrop Grumman, Textron, and Lockheed Martin. The ETF stands out from the competition in that its equally weighted, and no stock takes preference over the other. This helps minimize company-specific risk. It is also cheaper than most other major defense ETFs.
In a nutshell
Aerospace and defense contractors have one major client, the US government, with the large budget, coupled with economic stability, which makes it the ideal customer. These contractors enjoy large contracts spanning several years, which ensures their continued revenue growth. With the current emphasis on research and development, you would not go wrong in investing in defense stocks at the moment. However, if your appetite for risk is running low, you can always invest in the much safer defense ETFs.
