Defense Stocks – What They Are & Why Should You Invest in Them
The stock market is famous for its peaks and valleys. Bear markets are followed by bull markets before more bear markets set in. Most recently, high inflation and rising interest rates, mixed with a war between Russia and Ukraine, caused another bear market to set in.
It’s relatively easy to invest in a bull market, but what do you do when the bears take hold? Consider investing in defense stocks.
What Are Defense Stocks?
Defense stocks represent military defense contractors and suppliers. These companies supply governments with fighter jets and other aerospace technology, information technology services, weaponry, and defense systems.
The best defense stocks are well-established companies like Lockheed Martin (LMT), General Dynamics (GD), and Raytheon Technologies (RTX) that have long-standing relationships with the U.S. and allied governments. Due to their long-term relationships and contracts, defense companies are known for relatively stable growth regardless of the state of the economy or the market.
Countries always have a need to protect themselves and are rarely willing to skimp on military equipment.
Most well-established stocks in the sector are dividend stocks. With long-term government contracts, these companies have a clear view of how much money they can expect to make and how much they can afford to share with investors. In many cases, they not only pay dividends but they’re known for increasing dividend payments to investors every year.
For example, look at the dividends from the companies above:
Lockheed Martin. Lockheed Martin trades with a dividend yield of about 2.6%. The company has also increased its dividend yield for the past 20 consecutive years according to MarketBeat.
General Dynamics. As a dividend aristocrat, General Dynamics pays a dividend yield of around 2.25% and has raised dividends every year for the past 32 consecutive years.
Raytheon Technologies. Raytheon Technologies is another dividend aristocrat after raising its dividend payments every year for the past 30 consecutive years. The company pays a dividend yield of around 2.30%.
Pros & Cons of Defense Stocks
Any time you consider making an investment, you should consider the pros and cons. Different types of stocks have characteristics that appeal to a unique set of investors.
Defense stocks are no different. After considering the pros and cons, you may want to load up or you may decide this isn’t the sector for you.
Big names on Wall Street have long been interested in the defense sector. Some of the reasons expert and beginner inventors alike enjoy investing in defense companies include:
Stable Growth. The defense industry is known for relatively low volatility and stable growth. Defense contractors generate revenue through long-term contracts with the U.S. and allied governments, the most powerful customers in the world with the deepest pockets.
Safe Havens. When the stock market turns red, investors run from tech companies, restaurant chains, and other cyclical sectors and look to protect their portfolios with safe-haven stocks. The defense sector is one of the corners of the stock market investors run to. After all, the government is going to pay for national defense even in an economic downturn.
Income. The top defense stocks are also dividend aristocrats or on their way to becoming one. These are companies that have a consistent history of not only paying dividends but increasing them every year for decades, making them a perfect option for income investors and retirees.
Inflation Protection. Defense companies also have a strong history of outpacing inflation. As input cost rises, these companies pass the cost on to their biggest customers — U.S. and allied governments. That makes their profits more stable in an inflationary environment than companies that serve consumers.
Invest in Your Security. Nobody likes to think about war or the need for our military to protect us in the event of an attack by a foreign nation. But our defense capabilities are crucial to our continued success as a country. When you invest in defense leaders, you invest in the teams who develop the technology that keeps our country and its allies one step ahead of the competition on the battlefield.
The defense sector is an exciting one that can add stability to your portfolio and generate income, but it’s not for everyone. Like any other type of stock, there are a few drawbacks you should think about before diving in.
Slow Growth. Defense stocks are relatively stable, offering safe harbor and often gains in a down market. Like most safe plays, they experience little volatility in either direction. So you won’t typically see dramatic growth in the sector, even when the bulls are running.
Supply Chain Risks. Supply chain blues have impacted everyone, but they can be a serious problem in the defense industry. Military contracts often require these companies to deliver on time or lose the order. When supply chain issues strike defense companies, they could lose contracts worth hundreds of millions of dollars.
Should You Invest in Defense Stocks?
Defense stocks fit well into most investment strategies. That’s because most sound investment strategies require you to allocate at least a small percentage of your portfolio to safe-haven investments like noncyclical stocks. There are some investors who shouldn’t invest in this category though.
You should invest in the defense sector if:
You’re an Income Investor. Defense stocks are a great option whether you’re interested in producing income through your investments. The top dogs in the industry are known for providing meaningful dividend payments that grow year after year.
You’re a Risk-Averse Investor. These stocks are known for low levels of volatility and typically outpace the S&P 500 market index in bear markets. In the 2022 bear market, Lockheed Martin was up nearly 20% at the same time the S&P was down more than 20%. Low volatility and stellar performance in down markets make defense contractors a perfect pick if you’re not interested in taking significant risks.
You Need Solid Safe-Haven Allocation. Even the biggest risk-takers on Wall Street like to hedge their bets with safe havens — even if the safer plays only account for a small percentage of their overall portfolio. If that describes you, consider big players in the defense sector to fill in your safe-haven allocation.
You Enjoy Learning About Defense Technologies. Expert investors often advise beginners to invest in what they enjoy. That’s because if you enjoy learning about the product the companies you invest in produce, you’re more likely to do the research required to make sound investments. So if you enjoy movies like Top Gun and always click on articles about the greatest in military innovation, this is the perfect sector for you to research.
How Much of Your Portfolio Should You Allocate to Defense Stocks?
The amount of your portfolio you should allocate to defense stocks depends on multiple factors.
Defense stocks are a sturdy category that tends to perform better than market benchmarks in bear markets and poor economic conditions. But they provide stable (if unspectacular) growth in bull markets as well. Although they can be good holdings at any time, the current condition of the market should play a role in your allocation to defense stocks.
These stocks are most impressive to risk-tolerant income investors, but even risk-takers often find themselves hedging their bets with these stock market gems.
Answer the following questions to help determine how much of your portfolio to allocate to the defense industry:
Are You a Risk-Taker? If you answered yes, your allocation to this sector should be relatively minimal because it won’t produce the explosive growth you’re looking for. If you answered no, consider a more hefty allocation to the sector.
Are the Bulls or Bears In Control? If the bulls are running, you may want to consider investing in a more cyclical category to take advantage of the upward growth and make minimal investments in defense. If you’re in or approaching a bear market, now is the time to increase your defense holdings.
Are Dividends Important to You? If you answered yes, consider a hefty allocation to the leaders of the sector for their reliable, growing dividends. If you answered no, chances are you want more exposure to growth stocks than income stocks and you should limit exposure to defense.
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Article initially appeared on moneycrashers.com
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