Editors' pick: Originally published May 13, 2016.
No matter who wins the White House this fall, one thing is clear: Defense spending will climb.
Neither Hillary Clinton nor Donald Trump has been shy about their desire for a muscular foreign policy. And following the rise of ISIS and ever-bolder moves by China and Russia, allies of the United States are swiftly reversing course on years of defense cuts. One example is Germany, where the government recently proposed a 6.8% increase in military spending, well ahead of the overall federal budget's 2.7% growth rate.
Founded in 1952 and based in Falls Church, Va., the company supplies U.S. military mainstays such as the Abrams tank, the Los Angeles-class nuclear submarine and the Stryker light-armored vehicle. General Dynamics also develops information technology systems for the military and turns out commercial and civilian products, such as Gulfstream business jets, Medicare-related computer systems and oil tankers.
With a product lineup like that, it shouldn't come as a surprise that General Dynamics leans heavily on the U.S. government for business. That puts it in a great position to profit as America puts more cash into its military but also leaves the company exposed if the political wind shifts away from higher defense spending.
The good news is that the company has been working hard to diversify beyond Uncle Sam, with the percentage of sales coming from the U.S. government falling to 57% last year from 62% in 2013. That has occurred as non-U.S. customers make up an ever-growing share of the company's top line: 26% last year, compared with 20% in 2013.
General Dynamics' wide range of products helped steady its first-quarter sales, which came in at $7.72 billion, just below $7.78 billion a year earlier. A big jump in revenue at the marine systems business nearly offset declines at combat systems, information technology and aerospace due to the stronger dollar and lower demand for business jets.
Earnings, however, shot up 7.5%, to $2.30 a share, blowing past the consensus estimate of $2.16, as General Dynamics expanded its operating margin by 40 basis points to 13.6%.
The company's continuing buybacks also help support earnings per share by cutting the number of shares outstanding. In March, General Dynamics announced a 10-million-share repurchase and said that it took 7.8 million of its shares off the market in the first quarter.
Meanwhile, investors continue to enjoy steady dividend hikes.
Also in March, General Dynamics announced a 10% increase to its quarterly payout, marking its 19th consecutive annual rise. The dividend yield stands at 2.1%.
Despite a strong run-up for defense stocks this year, General Dynamics stands out for its reasonable valuation of 15.4 times forecast 2016 earnings, which is a discount to its industry, at 16.8, and competitors such as Northrop Grumman, at 20.4.
Analysts, for their part, see more gains ahead. The average 12-month price target is $167, which would represent a gain of about 15%.
The upshot? With military spending trending higher, the recent rise in defense stocks has plenty of room to run yet.
With its attractive valuation, shareholder-friendly approach and growing business, General Dynamics definitely deserves a place on investors' watch lists.
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This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.