Growth for these defense stocks as global tensions rise

January 19, 2024 at 09:12 AM EST

Defense stocks outlook

They’re not the most glamorous or high-profile stocks, but in the past month, big defense companies like TransDigm Group Inc. (NYSE: TDG), RTX Corp. (NYSE: RTX), the company formerly known as Raytheon, and Lockheed Martin Corp. (NYSE: LMT) outperformed the S&P 500 as geopolitical worries heat up.

Those are among the largest defense stocks by market capitalization. On a one-month basis, TransDigm and RTX are the top performers within the Industrial Select Sector SPDR Fund (NYSEARCA: XLI).

Defense stocks as a group got an initial boost back in February 2022 at the start of te Ukraine war, but then pulled back. They’ve been trending steadily higher since September 2022, but really took off in November.

Since then, greater concerns about tensions between China and the U.S., and the conflict between Israel and Palestine, have sent more dollars flowing into defense company coffers.

In a November 2023 report, Goldman Sachs investment officer Ashish Shah wrote, “National security threats are growing in magnitude and complexity, driving wider need for the latest defense technologies. Companies positioned to benefit as the U.S. and other NATO countries increase their spend on high-tech surveillance and deterrence should do well.”

Tech R&D fast-growing area of defense industry

Defense spending includes technological research and development, which has been a fast-growing area of the wider industry. That’s also impacted industries that supply defense, such as semiconductors.

Chipmakers that are significant suppliers to the military and defense industry include Advanced Micro Devices Inc. (NASDAQ: AMD) and Broadcom Inc. (NASDAQ: AVGO). However, because chipmakers’ businesses are so wide-ranging, and generative AI has been the dominant growth driver for the chip industry, it’s difficult to pinpoint how much of the rally in those stocks to attribute to defense spending.

The ranks of defense contractors also include cloud titans Amazon.com Inc. (NASDAQ: AMZN), Alphabet Inc. (NASDAQ: GOOGL), Microsoft Corp. (NASDAQ: MSFT) and Oracle Corp. (NYSE: ORCL).

The contracts, awarded in 2022, entail providing the U.S. defense department with “globally available cloud services across all security domains and classification levels, from the strategic level to the tactical edge,” through approximately June 2028.

Chipmakers, cloud computing companies, cybersecurity specialists and other techs can certainly see revenue boosts through these defense-related government contracts.

Unique mix of growth and income traits

But how will those typically classified as defense stocks perform as their revenues increase and investors view these companies as a hedge against geopolitical uncertainty?

While the increased defense spending globally is clearly a revenue driver, defense stocks may be at an unusual meeting point between growth and income, which could attract both types of investors.

In a December blog post, “Aerospace & Defense Stocks Surge: The New Geopolitical Trade?”, asset manager Direxion noted that interest in AI, the dominant growth trade in recent months, could boost defense stocks.

“The recent strength in defense stocks may be some residual effect of the recent excitement over AI, which figures to play a key role in the defense industry in the future.”

But as Direxion also noted, “Although short-term traders clearly aren’t interested in dividends, the reality is that some long-term investors are attracted to the dividend yields of aerospace and defense stocks. This is another factor that may keep a bid under the sector.”

Lockheed Martin’s dividend yield is 2.74%. The RTX dividend yield is 2.76%, while the Northrup Grumman dividend yield is 1.58%.

TransDigm: Appealing to wide range of investors

TransDigm has been a leader not only in the aerospace industry and industrial sector, but also within the broader market. In fact, it’s made it onto several growth stock screens in the past few months, after gapping out of a flat base in November.

You can see that price action on the TransDigm chart.

In the past year, TransDigm has outperformed the S&P by a wide margin, giving it some appeal to growth investors.

But, to Direxion’s point, it also makes a case for income seekers.

MarketBeat’s TransDigm dividend data shows the company doesn’t pay out shareholders every quarter, but instead pays special dividends that can be quite substantial.

In November, the company authorized a special cash dividend of $35 per share.

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Growth for these defense stocks as global tensions rise

Tech R&D fast-growing area of defense industry

Unique mix of growth and income traits

TransDigm: Appealing to wide range of investors

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