The defense industry apparently remains unwavered in the midst of the coronavirus crisis. Defense budgets are expected to expand worldwide and analysts believe defense stocks are ripe for investment to take profits in 2021 and beyond. In this article we take a look at the 10 best defense stocks to buy for 2021 by analyzing the hedge fund sentiment and core business outlook of these companies. Click to skip our detailed discussion and jump to the 5 Best Defense Stocks to Buy for 2021.
The defense industry is one of the evergreen sectors to invest in, owing to the evolving warfare techniques, increasing demand amid a rapidly changing world order and geopolitical tensions. According to a report titled United States of America’s Defense Budget Analysis – Competitive Landscape and Forecasts published by ResearchAndMarkets, the U.S. defense budget will reach $716.2 billion in fiscal 2021. The arrival of Joe Biden in the White House is expected to spur growth in the defense sector, as the upcoming President is a staunch supporter of U.S. supremacy on the global stage, especially against China and Russia. Biden also supports investing heavily in emerging warfare trends and futuristic weapons instead of spending on traditional weapons.
Deloitte said in a report that the defense sector will remain stable in 2021 as most countries have no plans to cut their defense budgets amid geopolitical tensions. The firm estimates that global defense spending will rise about 2.8% in 2021 and cross the $2 trillion mark. Deloitte, however, said that domestic defense spending will be lukewarm and there would be an additional downward pressure on defense budget in fiscal 2022 amid the coronavirus-related stimulus packages. However, the report said that this slowdown will be offset by huge foreign military sales of the United States army, which reached $83.5 billion in 2020.
A Thriving Defense Industry and Exports
U.S. defense stocks are the biggest beneficiaries of massive deals signed by the government to sell weapons and defense equipment to other countries. Since 2002, the U.S. has sold over $197 billion worth of conventional weapons and equipment to 167 countries. Notable deals signed by President Trump include the $23 billion arms sale agreement with the United Arab Emirates and the 2017 agreement with Saudi Arabia for a whopping $110 billion worth of weapons. Major companies working with the U.S. government to sell defense equipment to other countries include Lockheed Martin Corporation (LMT), Boeing Co (BA), Northrop Grumman Corporation (NOC), Raytheon Technologies Corp (RTX) and General Dynamics Corporation (GD).
According to data from the Stockholm International Peace Research Institute (SIPRI), the U.S. has the biggest arms industry in the world, followed by China. SIPRI said that sales of arms and military services by the world’s top 25 companies increased 8.5% in 2020 to reach $361 billion last year. Twelve of these companies are from the U.S, with big 5 accounting for $166 billion of total sales.
Foreseeing the trajectory of financial markets is becoming harder than ever. Even the so-called experts are failing at it. The hedge fund industry’s reputation has been tarnished in the last decade during which its hedged returns couldn’t keep up with the unhedged returns of the market indices. On the other hand, Insider Monkey’s research was able to identify in advance a select group of hedge fund holdings that outperformed the S&P 500 ETFs by more than 88 percentage points since March 2017 (see the details here). We were also able to identify in advance a select group of hedge fund holdings that significantly underperformed the market. We have been tracking and sharing the list of these stocks since February 2017 and they lost 13% through November 16. That’s why we believe hedge fund sentiment is an extremely useful indicator that investors should pay attention to. You can subscribe to our free newsletter on our homepage to receive our stories in your inbox.
Defense stocks have historically been recession-proof, mainly because of the government’s ability to pay huge bills even during harsh times. The S&P Aerospace & Defense Select Industry Index is up over 5% in 2020. As the U.S. government seeks to rid itself of the cold war remnants and update its weapons arsenal to compete with China and Russia, defense stocks will continue to experience growth in 2021 and beyond.
Let’s see the 10 best defense stocks to buy for 2021 by analyzing the data released by famous hedge funds and fundamentals of top defense companies.
10. Leidos Holdings Inc (NYSE: LDOS)
Leidos Holdings Inc (NYSE: LDOS) ranks 10th in our list of the 10 best defense stocks to buy for 2021. The company provides aviation, IT, integration and technical services in the defense sector. It acquired Cloud service provider 1901 Group for $215M in December. The company beat third-quarter earnings estimates, posting a non-GAAP EPS of $1.47 and revenue of $3.24 billion.
In October, Leidos won a $306 million follow-on contract by Redstone Arsenal, Alabama. The company will provide ground and flight operations services for the Saturn Arch aircraft in Outside the Contiguous United States contingency environments.
A total of 25 hedge funds tracked by Insider Monkey held stakes in Leidos at the end of the third quarter, down from 35 funds a quarter earlier.
HII ranks 9th among the 10 best defense stocks to buy for 2021. Virginia-based Huntington Ingalls Industries is the nation’s largest shipbuilding company, which was created as a result of a spinoff of Northrop Grumman in 2011. In November, the company won a $2.2 billion contract modification from General Dynamics Electric Boat for the construction on the first two Columbia-class ballistic missile submarines. In the third quarter, the company posted an adjusted EPS of $3.73, versus $3.23 in the same period of 2019. The company expects its revenue to fall in the upper range of its 2020 outlook.
Cliff Asness’ AQR Capital Management is among the 29 hedge funds long Huntington as of the end of the third quarter, with 874,708 shares, worth $123.12 million. We shared an investor’s bullish HII thesis in this article a couple of months ago.
8. Perspecta Inc (NYSE: PRSP)
PRSP ranks 8th in our list of the 10 best defense stocks to buy for 2021. A total of 36 hedge funds reported owning stakes in Perspecta as of the end of the third quarter. The combined value of these stakes is $689.1 million. Barry Rosenstein’s JANA Partners is the top shareholder, with 12,799,872 shares of the company, worth $248.96 million. In December, Perspecta was awarded an extension of the NGEN (Next Generation Enterprise Network) contract from the U.S. Department of the Navy with a maximum value of $797 million.
The company also won a contract for systems engineering and integration for Space Development Agency. The company will establish transport Layer, tracking Layer and ground segment operations for the agency.
In its Q3 2020 Investor Letter, Carillon Eagle Mid Cap Growth Fund said the following about Perspecta.
“Perspecta provides end-to-end enterprise information technology services to government customers across the U.S. federal, state, and local markets. Investors were disappointed as the company has been unable to accelerate revenue growth after an unforeseen loss of a major contract in the earlier part of the year. We remain shareholders due to the combination of healthy project wins that foreshadow growth, very attractive valuation vs. peers, and activist investor involvement.”
GD ranks 7th in our list of the 10 best defense stocks to buy now. General Dynamics Corporation is a Fortune 500 company and the fifth-largest defense contractor in the United States. The company recently won a $4.6 billion contract from the U.S. Army to build the latest iteration of the M1 Abrams battle tank. The company also won a $100.04 million contract for the execution of the USS Comstock fiscal 2021 Chief of Naval Operations scheduled docking.
In the third quarter, General Dynamics crushed analysts’ forecasts for EPS. Operating margin in the quarter came in at 11.5%, a 240 basis-point increase, driven by a 620 bps jump in the Aerospace segment’s margin. The stock is down 15% year to date.
Out of 816 hedge funds tracked by Insider Monkey, 37 had General Dynamics stock in their portfolios, as of the end of the third quarter. James A. Star’s Longview Asset Management owns 32,212,32 shares of the company, worth $4.4 billion. Oakmark Funds shared its long-term bullish thesis in its 2020 Q2 investor letter:
“General Dynamics is one of the leading U.S. defense contractors and controls the world’s premier business jet franchise (Gulfstream). Short-term fears that the coronavirus will hurt demand for business jets drove down the share price, so we were able to purchase this high-quality business at a large discount to both its historical and peer valuation levels. Taking a longer term view, we believe the company is poised to benefit from new product introductions within its business jet division, an improvement in free cash flow conversion and a highly visible, decade-long increase in deliveries of next generation nuclear-powered submarines. As these positives come into clearer view, we believe the discount to intrinsic value will close.”
Honeywell stands 6th on the list of 10 best defense stocks to buy for 2021, as 41 hedge funds tracked by Insider Monkey own stakes in the company, worth $970.92 million.
Honeywell is a North Carolina-based company that makes aerospace systems and defense technologies, along with performance materials and safety solutions. The company recently won a $1.11 billion modification to the contract for the Automotive Gas Turbine 1500 engine program by the U.S. Army Contracting Command, Detroit Arsenal, Michigan.
In the third quarter, Honeywell posted upbeat results amid a double-digit growth in its defense and space, warehouse automation and PPE products business.
Billionaire D E Shaw’s hedge fund owns 582,179 shares of the company, worth $95.83 million. Here is what Fiduciary Management said about Honeywell earlier in 2020:
“Honeywell has established market-leading positions in innovative technologies. They have an excellent service and support network, with a large installed base of equipment. This installed base is mission-critical and creates aftermarket sales opportunities. The ROIC is greater than 20%. The company has a strong and deep management bench and an excellent corporate culture. Honeywell is conservatively-run from a business, accounting, and balance sheet perspective. With exposure to Aerospace (45% of profit) and Oil & Gas (15-20% of profit), the stock came under recent pressure. Within Aerospace, commercial aftermarket, defense, and commercial original equipment account for 16%, 14%, and 8% of total company sales, respectively, the latter of which includes business jets and general aviation. Oil & Gas has proven to be resilient as it is predominantly mid/downstream, with the upstream accounting for just 2-3% of total sales. The company has a strong balance sheet. The stock trades at a mid-teens free cash flow multiple.”
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