So, sequestration happened. While that’s not great, and it could definitely make things interesting for a while, one sector I’m not too concerned about is defense contracting, specifically defense giants. Yeah, it’ll be bumpy, but they’ll survive. They’re the proverbial tortoise: slow and steady. So why do investors invest in them? Dividends. And, understandably, there’s concern over what, if any, impact sequestration will have on defense dividends. Here’s what you need to know.
Dividends are paid from net income. In other words, the cash that’s left after taxes, expenses, etc. So, for example, let’s say Lockheed Martin Corporation (NYSE:LMT) takes a hit in its profit because the government isn’t spending as much money. In theory, that could impact its dividend. Well, sequestration will definitely impact defense companies’ profits, so does that mean defense dividends will take a hit? Unlikely, and it’ll probably be minimal if they do. Here’s why:
Lockheed Martin Corporation (NYSE:LMT), The Boeing Company (NYSE:BA) , Northrop Grumman Corporation (NYSE:NOC) , Rockwell Collins, Inc. (NYSE:COL) , and United Technologies Corporation (NYSE:UTX) , all pay dividends, which is great for investors. Even better? Their dividend payout ratio is pretty low, and because of that, sustainable even if affected by sequestration. Take a look: Lockheed Martin Corporation (NYSE:LMT)’s payout ratio is the highest at 50%, and United Technologies’ is second at 38%. The Boeing Company (NYSE:BA) and Rockwell are tied for third with a payout ratio of 34%, and Northrop has the lowest payout ratio, at 28%.
Another factor to keep in mind? While sequestration does mean a reduction in defense spending, it’s only returning defense spending to 2007 levels. In other words, there’s still a heck of a lot of defense spending going on, so these companies aren’t going to see all their revenue vanish overnight. Go down? Yes. Dry up? Nope. What’s more, these companies’ market caps are in the billions. They’re not small companies that can’t take a little turbulence. That’s not to say they won’t be affected; they undoubtedly will be. But they’re resilient.