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.

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), 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.

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.

There appears to be consensus that defense spending will remain intact for the first year of the new president's term, assuming prolonged economic weakness. The war in Iraq and increased military involvement in Afghanistan could benefit companies. Current uncertainty may represent an unusual buying opportunity or, alternately, a forecast of future decline. Consider macroeconomic, political and idiosyncratic risk before investing in aerospace and defense companies.
Employees of TheStreet.com Ratings with access to pre-publication ratings data must pre-clear any potential trade through the legal department and are prohibited from trading any security that is the subject of an unpublished rating revision until the second business day after the rating is published. While employees cannot provide investment advice or recommendations, the writer appreciates your feedback and can be reached at jake.lynch@thestreet.com.

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