Last week with the Durable Dividends article, I highlighted the fact that there are potentially attractive options available for dividend growth investors to consider in the technology sector as that area of the market sells off. Throughout much of 2022, tech stocks have been near the top of many investors’ minds because of the stark sell-off that we’ve seen in that sector. Tech stocks posted outperformance throughout much of the last decade, so taking advantage of relatively rare weakness there makes sense. But, since my last Durable Dividends article we’ve witnessed the Russian invasion of Ukraine, which has caused many investors to wonder whether or not they have enough defensive positions in their portfolios. The pivot to a more risk-off mindset is certainly a rational response to the threat of war spreading across Europe. This week, I’ve seen a lot of discussion of things like energy stocks, which should do well as geopolitical tensions rise, and consumer staple plays, which tend to post solid performance, regardless of the macro economic environment. However, when it comes to the most direct defensive plays and even hedges against market volatility in a war-torn market, the most intense spotlight appears to shine on the defense contractors, which are likely to be direct beneficiaries of the fear inspired by Russian aggression.
Unlike the tech stocks, which many income oriented investors tend to ignore, the defense contractors are common stocks for dividend growth investors to follow because they tend to be very generous with their cash flows via shareholder returns (rising dividends and stock buybacks).
What’s more, these stocks tend to trade with relatively cheap valuations, which is something that is likely to put a conservative investors’ mind at ease.
I’ve always found it interesting that defense stocks, which tend to work on cutting edge technologies, trade with such low valuations. In many cases, the products and services that these companies are working on developing are just as interesting and exciting as the technology that drives premium multiples amongst the popular tech stocks like Alphabet (GOOGL), Amazon (AMZN), Apple (AAPL), Tesla (TSLA), and the like.
For instance, things like automation, advanced manufacturing, artificial intelligence, alternative energy, cyber security, and space exploration – all industries which benefit from strong, long-term, secular trends – are priorities for the defense stocks that I’ll discuss below.
Heck, you don’t have to spend much time browsing space alien related shows or documentaries on Discovery channel to hear stories of companies in the private sector like Lockheed Martin (LMT) or Northrop Grumman (NOC) partnering with the U.S. government to reverse engineer alien technology which has supposedly crashed down onto Earth. Obviously, these stories are all rumored. They’re speculative at best and conspiracy theories at worst; however, if you’re someone who believes that we’ve not alone in the Universe and that we have had off-planet visitation, it doesn’t get more cutting edge in the technology space than flying saucers.
All joking aside, the reason that defense contractors don’t trade with the same sort of speculative growth multiples that big-tech stocks do is because their products/services have relatively limited total addressable markets (TAMs) because they’re not being offered to the general population, but instead, largely the U.S. government and its allies.
But, while there is a downside to TAM limitations, there is an upside to selling goods/services to the U.S. government…
As we’ve seen in recent years, this is a customer which has the ability to literally print cash to make its payments. Therefore, we arrive back at the defensive cash flow augment…defense contractors may not have the same rapid growth prospects as big-tech, but they do generate very reliable earnings because of the fact that their customers are always flush with cash.
And, in today’s world, where defense spending is a priority at home and abroad due to the belligerent nature of many of America’s adversaries, I think these reliable growth prospects remain in place (and are even likely to accelerate).
Joe Biden has already increased the United States defense budget well above the levels put in place by former President Donald Trump. Then, a bi-partisan congressional committee actually increased this level of spending further. In the coming weeks, we should see the Biden administration’s longer-term defense spending plans. And, in light of the Russia/Ukraine situation, I have a feeling that we’ll be looking at even larger investment figures.
Just this morning, I saw a headline stating that Germany is planning on bolstering its defense spending by creating a special 100 billion euro special defense spending fund in the present – German Chancellor Olaf Scholz also announced that his country will expand its defense budget to more than 2% of its annual gross domestic product moving forward.
I suspect that we’ll see similar announcements by other NATO countries in the coming days/weeks and all of this bodes well for the U.S. defense contractors which will be leading competitors for the new defense contracts that this increased spending creates.
So, with all of that being said, let’s take a look at a handful of the most notable dividend growth stocks in the defense contractor space…
In this article I won’t be spending time discussing each company’s operations/specific operating segment growth outlook (that information is reserved for deeper dives which reside behind paywalls). However, I am happy to highlight the present fundamentals, the dividend safety/growth metrics, the consensus growth outlooks by Wall Street analysts, and the relative valuation figures that each company offers to sort of serve as a jumping off point for investors’ own due diligence processes.
Up first, we have Lockheed Martin. This is a $111.5 billion market cap company. LMT shares rose 5.96% last week on the Russian invasion news. Year-to-date, LMT shares are now up 15.22%. And yet, even after this strong rally, I don’t believe that shares look particularly expensive. LMT currently trades with a blended price-to-earnings ratio of 17.5x. On a forward basis, looking at Wall Street’s consensus 2022 earnings-per-share estimate of $26.75, we see that shares are trading with a forward P/E ratio of just 15.3x. LMT’s 5, 10, and 20-year average P/E ratios come in at 16.08x, 16.82x, and 16.39x, respectively. Therefore, on a forward basis, these shares are still trading below their long-term averages. And, with regard to the dividend, we see that after its 15%+ ytd rally, LMT still yields 2.74% (which is more than twice as high as the S&P 500’s 1.31% yield). LMT is currently on a 19-year consecutive dividend growth streak. The company’s 5 and 10-year dividend growth rates are 9.4% and 12.5%, respectively. Lockheed’s most recent dividend increase came in at 7.7% (announced in September of 2021). And, because of the stock’s relatively conservative forward payout ratio (of just 41.9%) and the 18% EPS growth prospects that the company offers in 2022, I expect to see another high single digit/low double digit raise announced in the Fall of 2022 (basically, pointing towards another raise that is in-line with LMTs historical averages).
Up next, we’ll check out the aforementioned Northrop Grumman. NOC’s market cap currently sits at $63.95 billion. This company saw its share rise by 4.71% last week on the Russian news. NOC shares are up 5.84% on a year-to-date basis. Right now, NOC yields 1.53% (much lower than LMT’s dividend yield, but still above the S&P 500’s). However, where NOC shines is in the dividend growth department. NOC is on an 18-year consecutive dividend increase streak. And, the company’s 5 and 10-year dividend growth rates are 12% and 12.3%, respectively. NOC’s most recent dividend increase was 8.3%, declared in May of 2021. Right now, analysts are expecting to see relatively tepid growth here in 2022 (largely because of inflationary and supply chain headwinds). On the bottom-line, the Wall Street consensus growth rate for NOC in 2022 is currently -3%. However, even with this negative EPS growth estimate in place, NOC’s forward EPS dividend payout ratio remains very attractive at just 25.3%. With that in mind, I believe that the company will provide yet another high single digit dividend increase in 2022. And, in terms of valuation, we see that NOC shares are currently trading with a blended P/E multiple of 16.06x. On a forward basis, using the consensus Wall Street estimate of $24.86/share in 2022, we see that shares are trading with a forward P/E multiple approximately 16.5x. This figure is above NOC’s average 5-year, 10-year, and 20-year P/E multiples of 14.7x, 15.2x, and 14.3x – seemingly implying that NOC is not quite as attractive of a bargain as LMT at its current price point.
General Dynamics (GD) is another large cap defense stock (current market cap of $63.19 billion) that offers investors exposure to an attractive dividend growth history. GD is on a 30-year dividend growth streak. The company’s 5 and 10-year dividend growth rates are 9.5% and 9.8%, respectively. GD’s most recent dividend increase came in at 8.2% (announced in early March of 2021). GD posted EPS growth of 5% in 2021 and the consensus analyst estimate calls for another 5% growth in 2022. GD’s forward payout ratio is currently 39.2%. Therefore, I believe that the company will announce another mid-to-high single digit dividend increase in the coming weeks. GD shares were up 5.63% last week. On a year-to-date basis, they’re up 9.36%. After this rally shares trade with a blended P/E ratio of 19.58x. On a forward looking basis, GD’s P/E ratio is currently 18.76x. GD’s 5, 10, and 20-year average P/E multiples stand at 15.6x, 15.8x, and 15.16x, respectively. Therefore, once again, it appears that the recent bullish sentiment surrounding GD has pushed its share price up to a historically high premium. But, even if shares are slightly overvalued, that doesn’t change my belief that this company’s 2.09% dividend looks quite safe and I wouldn’t be surprised if GD served as a sleep-well-at-night type of defensive position throughout this geopolitical volatility.
L3Harris Technologies (LHX) sports a 45.82 billion market cap after its 7.3% rally last week. Year-to-date, LHX shares are now up 9.51%. And yet, even after this strong rally, I think there’s an argument to be made that LHX is still attractively valued. LHX’s current blended P/E ratio is 17.89x. On a forward looking basis, based upon the market’s consensus 2022 EPS estimate of $13.60 (which represents 5% y/y growth compared to 2021’s total), LHX is trading with a 17.16x P/E multiple. LHX’s average 5, 10, and 20-year P/E ratios are 19.48x, 16.19x, and 17.10x. Therefore, we see that the stock’s current and forward P/E multiples are below its 5-year average, but above its longer-term results. From a dividend growth perspective, LHX remains one of my favorite defense stocks. In 2021, LHX raised its dividend by 20%. And, just last week, the company announced its 2022 dividend increase, which came in at 9.8%. This pushed the stock’s forward yield up to 1.92% (well above the SPY’s 1.31% level). And, these double digit raises (I’m happy to give LHX the benefit of the doubt, rounded that 9.8% raise up to 10%) have been a regular occurance for this company over the years. LHX just extended its dividend growth streak to 21 years. And, the company’s 5 and 10-year dividend growth rates come in at 14.6% and 14.4%, respectively.
Raytheon Technologies (RTX) is the last large-cap defense stock that I’ll discuss in this piece (this edition of Durable Dividends is already quite a bit longer than my usual 1,200-1,500 word target). RTX shares were up 5.09% last week. Year-to-date, RTX is now up 14.01%. The company’s market cap now sits at $145.72 billion (making it the largest company on this list, but when it comes to RTX, it’s important to remember that it’s not a pure play defense contractor; the company has significant sales/cash flows coming from the commercial aerospace markets as well). RTX currently yields 2.08%. The stock does not have a long-term dividend growth streak because of recent M&A and the struggles that its commercial operations had during 2020 related to the COVID-19 pandemic. However, RTX does offer exposure to a dividend that has trended upwards over the years, with a 5-year DGR of 5.33% and a 10-year DGR of 6.19%. RTX’s most recent dividend raise came in at 7.4%. And, looking ahead to 2022’s increase, I expect to see an even higher announcement due to the strong EPS growth results that RTX posed in 2021 (where EPS rose by 56% as sales bounced back from the COVID-19 recession lows). Analysts are calling for RTX to produce 12% EPS growth in 2022 and another 21% in 2023. Therefore, I think this company has the potential to generate double digit dividend growth in the coming years. RTX’s current forward payout ratio looks very attractive at just 42.5%. RTX shares currently trade with a blended P/E ratio of 22.55x. However, because of the strong forward growth prospects, we see that shares trade with forward multiples of 20.44x and 16.85x when looking at the consensus 2022 and 2023 EPS estimates. RTX’s average 5, 10, and 20-year P/E ratios come in at 19.16x, 17.5x, and 17.0x, meaning that the growth potential here implies that shares are hovering near historical fair value levels.
At the end of the day, when thinking about all of these positive year-to-date growth figures, it’s important to remember, the S&P 500 is currently down 7.83% on a year-to-date basis. Therefore, not only do these defense stocks offer exposure to reliably increase dividends, but they’re also generated strong alpha during 2022 thus far. I wouldn’t be surprised to see that continue due to the world’s geopolitical strife. As for me, I know that I sleep well at night with exposure to many of these stocks (I’m long LMT, NOC, LHX, and RTX) in my personal portfolio.
Disclosure: Of the stocks discussed in this article, Nicholas Ward is long LMT, NOC, LHX, and RTX, AMZN, AAPL, and GOOGL.
This article is intended to provide information to interested parties. As we have no knowledge of individual circumstances, goals and/or portfolio concentration or diversification, readers are expected to complete their own due diligence before purchasing any stocks mentioned or recommended. It does not guarantee that securities mentioned in this newsletter will produce profits or that they will equal past performance. Additionally, we are not an investment advisor and do not offer securities or tax advice. Although all content is derived from data believed to be reliable, accuracy cannot be guaranteed. Nicholas Ward, contributors and staff members of Wide Moat Research may hold positions in some or all of the stocks listed.
Nicholas Ward is a research analyst who currently writes for Seeking Alpha, The Dividend Kings, iREIT, and Forbes Real Estate Investor. Before that, he was Founder and Editor-in-Chief of The Dividend Growth Club, as well as the Income Minded Millennial. Nicholas has also contributed to Sure Dividend, Investing Daily, and The Street, where he covered stocks in Jim Cramer's Action Alerts PLUS Portfolio.
Nicholas holds a bachelor of arts from The University of Virginia, where he studied English and studio art. Prior to transitioning into the financial industry, he managed a vineyard in the foothills of the Blue Ridge Mountains.
