Defense Companies Earn Their Name

Several aerospace and defense companies recently posted record quarters. Axsys Technologies(AXYS Quote), Applied Signal Technology(APSG Quote), Hi-Shear Technology(HSR Quote), Raytheon(RTN Quote) and Elbit Systems(ESLT Quote) are top-sector performers, according to our quantitative model. As our list of "buy"-rated stocks dwindles, these five have maintained the highest marks, indicating strong fundamentals.

Company Ticker Quarterly Revenue Quarterly Net Income YTD Return Cheap Expensive Applied Signal Tech. APSG 26% increase 101% increase 6% P/B,P/CF P/E, P/S Axsys Technologies AXYS 43% increase 93% increase 60% - P/B, P/CF, P/E, P/S Elbit Systems ESLT 40% increase 4609% increase -32% P/CF,P/S P/B, P/E Hi-Shear Technology HSR 7% increase 3% increase -29% P/CF P/B, P/E, P/S Raytheon RTN 12% increase 43% increase -23% P/B, P/CF P/E, P/S Source: TheStreet.com Ratings

On the flip side, here are three aerospace and defense stocks that have recently underperformed. Aerosonic(AIM Quote), Tri-S Security(TRIS Quote) and Environmental Tectonics(ETC Quote) are rated "sell" by our quantitative model. However, all three companies improved revenue, lowered their net loss and made progress toward profitability in the latest quarter.

Company Ticker Quarterly Revenue Quarterly Net Income YTD Return Cheap Expensive Aerosonic AIM 13% increase 82% decrease -86% P/B,P/S - Environmental Tectonics ETC 105% increase 46% decrease -14% P/S P/CF Tri-S Security TRIS 79% increase 6% decrease -64% P/B,P/S - Source: TheStreet.com Ratings

Defense stocks usually hold up well during recessions because a substantial portion of industry revenue is derived from U.S. government contracts. Still, stock-market pessimism and political uncertainty are risks. Key legislators are advocating a cut in defense spending to counter increased spending on the financial bailout. Pentagon officials recently warned that defense spending is on the chopping block.

Speculation that the Obama administration will increase contract oversight is adding to worries. That would make it more difficult for defense companies to win government contracts and might put pressure on an industry accustomed to wide margins. The 2009 Defense Authorization Act was passed on Oct. 14. Two of the bill's main goals are to restrict the use of non-competitive contracts and to provide more transparency on government spending.

Analysts predict that some defense companies stand to benefit from more competition. Small firms with innovative technologies may be poised for a jump. Prime contractors and those involved in combat-systems development, an arguably bloated portion of defense spending, could be damaged by new legislation.