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Defense Companies Earn Their Name

Stocks in this article: AXYS RTN ETC

Several aerospace and defense companies recently posted record quarters. Axsys Technologies (AXYS), Applied Signal Technology (APSG), Hi-Shear Technology (HSR), Raytheon (RTN) and Elbit Systems (ESLT) 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.

Quarterly Revenue
Quarterly Net Income
YTD Return
Applied Signal Tech.
26% increase
101% increase
P/E, P/S
Axsys Technologies
43% increase
93% increase
P/B, P/CF, P/E, P/S
Elbit Systems
40% increase
4609% increase
P/B, P/E
Hi-Shear Technology
7% increase
3% increase
P/B, P/E, P/S
12% increase
43% increase
P/E, P/S
Source: Ratings

On the flip side, here are three aerospace and defense stocks that have recently underperformed. Aerosonic (AIM), Tri-S Security (TRIS) and Environmental Tectonics (ETC) 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.

Quarterly Revenue
Quarterly Net Income
YTD Return
13% increase
82% decrease
Environmental Tectonics
105% increase
46% decrease
Tri-S Security
79% increase
6% decrease
Source: 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.

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