The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.
NEW YORK ( MagicDiligence.com) -- We believe defense contractors, home health agencies and for-profit education could face disproportionate hits from spending pullbacks as a result of the just-passed debt deal. The deal allows the federal government to raise the debt ceiling by $2.4 trillion. To balance this act, there is an initial $917 billion in spending cuts over the next 10 years. Additionally, a congressional committee will be appointed to find another $1.5 trillion in spending to cut, by Thanksgiving of this year. If the committee does not come to an agreement, a pre-arranged set of spending cuts will kick in (the "trigger cuts").
Let's take a look at the current Magic Formula stocks in three well-represented Magic Formula Investing sectors that are now at risk.
Defense ContractorsOver the years, defense contractors have enjoyed generally increasing budget dollars, combined with excellent competitive advantages stemming from long-term relationships with the Department of Defense, allowing good returns on capital. At the same time, due to a limited addressable market, investors have never bid up the stocks much, leading to relatively low valuations. This is a perfect scenario for showing up in the Magic Formula screens, and in fact, even in good times, this sector is a staple of the strategy.
Unfortunately, this is also probably the most obvious group hit by the debt-ceiling deal. Of the initial $917 billion in cuts, about a third come out of defense. Additionally, if the "trigger cuts" are reached, many analysts estimate another $600 billion, or more, will get taken out of defense. For firms that rely on federal defense dollars, this is a harrowing prospect.The Magic Formula stocks most affected are the ones that rely almost solely on the Feds for revenue. Lockheed Martin (LMT - Get Report), Northrup Grumman (NOC - Get Report), Raytheon (RTN - Get Report), SAIC (SAI), and ManTech (MANT - Get Report), all get 85% or more of revenue from the U.S. government. Other defense-oriented firms with a bit better private sector exposure include Harris (HRS), at ~65% exposure, and OshKosh (OSK), at 72% exposure. It is difficult to say exactly where the cuts will come, but it is likely that all of these firms will see reductions to at least some of their programs.