Editor's note: Our Pre-Memorial Day special examines military-related stocks and how to buy, sell or trade them. This feature includes a video by Gregg Greenberg, Defense-Stock Domination; and articles by Marc Courtenay One Priced to Buy; Robert Weinstein Bigger Guns, Bigger Profits; Richard Saintvilus Boeing's Offense Is Defense; Richard Suttmeier Sequester Survivors; and Richard Cox Bullish Earnings Support Defense.
NEW YORK ( TheStreet) -- In a so-called age of austerity and sequestration, the defense industry continues to thrive, aiming profits directly at investors.
These defense contractors have made new 52-week highs in the last two weeks, and have extended so rapidly that they are overbought on the daily chart. No worries, though. I will demonstrate how you can get your share of the defense industry with lower risk than your neighbor. Before explaining how to optimize a buy, we should consider why you should buy.Both companies are highly correlated in fundamentals and stock-price action. Often when I write or talk about two companies in the same sector, I get asked which one is the better investment. As a rule, if you're on the fence between two companies, you should choose the one you know or follow the most. The more you know about a company, the greater your edge, so stick with what you know the best.
If they're both the same to you, I'll help out with a tie breaking pick that I like best. NOC Net Income Quarterly data by YCharts
The first thing that may pop out at you is the revenue for both companies is declining, but the profit is growing. Obviously that can't go on forever, but it doesn't need to. Through effective cost control, margins have actually grown, not fallen as one may expect in a contracting economy and industry. For prospective and current investors, the most exciting aspect is how much room there is to grow. Even with over 10% gains in the last two years, Northrop and Raytheon have near single digit price-to-earnings ratios. What this means is that the market isn't pricing in growth, and at least at the surface level is discounting for a potential earnings contraction. NOC Profit Margin TTM data by YCharts
But it's the relatively low earnings multiples that represent a buying opportunity. Northrop pays a 3% yield, and Raytheon pays a slightly higher rate of 3.3%. The rates are paid from a relatively small percentage of profits, called a payout ratio. The payout ratio is under 30% for Northrop and 35% for Raytheon. All else being equal, I find 40% and under safe.
Select the service that is right for you!COMPARE ALL SERVICES
Jim Cramer and Stephanie Link actively manage a real portfolio and reveal their money management tactics while giving advanced notice before every trade.
- $2.5+ million portfolio
- Large-cap and dividend focus
- Intraday trade alerts from Cramer
- Weekly roundups
Access the tool that DOMINATES the Russell 2000 and the S&P 500.
- Buy, hold, or sell recommendations for over 4,300 stocks
- Unlimited research reports on your favorite stocks
- A custom stock screener
- Upgrade/downgrade alerts
Jim Cramer's protege, David Peltier, identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.
- Diversified model portfolio of dividend stocks
- Alerts when market news affect the portfolio
- Bi-weekly updates with exact steps to take - BUY, HOLD, SELL
All of Real Money, plus 15 more of Wall Street's sharpest minds delivering actionable trading ideas, a comprehensive look at the market, and fundamental and technical analysis.
- Real Money + Doug Kass Plus 15 more Wall Street Pros
- Intraday commentary & news
- Ultra-actionable trading ideas
Our options trading pros provide daily market commentary and over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.
- 100+ monthly options trading ideas
- Actionable options commentary & news
- Real-time trading community
- Options TV