Defense stocks have greatly rewarded their shareholders over the last decade. These stocks have hard-to-replicate expertise, which provides them with a wide moat in their business.

Investors who seek attractive long-term returns amid weak competition should consider including defense stocks in their portfolios. In this article, we will analyze the prospects of three defense stocks that are attractive right now.

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Northrop Grumman Corporation (NOC)

Northrop Grumman is one of the five largest U.S. aerospace and defense contractors. It operates in four business segments: Aeronautics Systems, Mission Systems, Defense Systems, and Space Systems.

The key competitive advantage of Northrop Grumman is its technical expertise, which is hard to replicate. Its platforms have decades-long life cycles and the company benefits from the maintenance and modernization of these platforms. As a result, Northrop Grumman is resistant to recessions. This has certainly proved to be the case during the coronavirus crisis, as the company has posted record earnings in 2020 and 2021. The only material risk of Northrop Grumman is a potential budget cut from the U.S. Department of Defense. This risk has occasionally showed up on the headlines but it has proved minimal over the long run.

In the most recent quarter, Northrop Grumman posted a 4% decrease in its sales due to a tight labor market, many employee leaves, and some supply chain disruptions due to the pandemic. However, the company won $6.9 billion of new contracts and thus grew its backlog to $74.8 billion. Thanks to positive business trends, management raised its guidance for the annual earnings per share from $24.40-$24.80 to an all-time high of $25.20-$25.60.

Northrop Grumman has more than tripled its earnings per share over the last decade. The primary growth drivers have been contract wins, modernization, and maintenance of fleet and share repurchases. In addition, the wide business moat has helped the company grow consistently. Given these growth drivers and the excessive backlog of $74.8 billion, which is equal to two years’ revenues, Northrop Grumman is likely to continue growing its earnings per share at a fast pace for many more years.

Lockheed Martin Corporation (LMT)

Lockheed Martin is the largest defense company in the world. It generates approximately 60% of its revenues from the U.S. Department of Defense, 10% from other U.S. government agencies and 30% from international clients.

Lockheed Martin proved its resilience to recessions last year. Despite the severe recession caused by the pandemic, the company grew its earnings per share 12%, to a new all-time high.

On the other hand, Lockheed Martin is facing a headwind this year due to the exit of the U.S. from Afghanistan. In the third quarter, its revenue dipped 3%, primarily due to lower volumes of F-35 and lower sales of tactical and strike missiles and sensors. Moreover, due to the exit from Afghanistan, management stated that it expects lower revenues in 2022 and pledged to reassess its 5-year business plan. Nevertheless, the company is still on track to grow its earnings per share 11% this year, to a new record level.

Lockheed Martin has grown its earnings per share at a 13.5% average annual rate over the last decade thanks to multiple growth drivers, such as strength in F-35 sales, tactical and strike missiles, defense programs, and the acquisition of Sikorsky. The F-35 is one of the most advanced stealth military aircraft in the world and hence it will remain a major growth driver going forward. The Pentagon plans to buy 2,456 F-35s, without including sales to allies. Overall, Lockheed Martin is facing a headwind due to the exit from Afghanistan but it is likely to continue growing significantly, in the long run, thanks to the aforementioned growth drivers.

Huntington Ingalls Industries (HII)

Huntington Ingalls Industries was spun out of Northrop Grumman in 2011. The company primarily builds nuclear and non-nuclear ships for the U.S. Navy.

As a prime defense contractor of the U.S., Huntington Ingalls has a dominant position in its business. Its main competitive advantage is its expertise in designing and manufacturing bespoke ships for the U.S. Navy. Indeed, in the U.S., the company is the only provider of nuclear aircraft carriers, the only provider of amphibious assault ships and one of the two providers of nuclear submarines. These platforms have decades-long life cycles, with Huntington Ingalls benefiting from their sustainment and modernization.

Thanks to these characteristics, the business model of Huntington Ingalls is resilient to recessions. This was clearly reflected in the performance of the company in 2020. Despite the pandemic, Huntington Ingalls grew its earnings per share 22%, to a new all-time high.

On the other hand, the company always faces the risk of program cuts and changes in naval requirements. Due to these headwinds, Huntington Ingalls has decelerated this year. In the third quarter, its revenue edged up 1% but its adjusted earnings per share dipped 4% over last year’s quarter. Due to lower demand for new ships and some supply chain disruptions caused by the pandemic, Huntington Ingalls is poised to incur an approximate 20% decrease in its earnings per share this year.

Moreover, Huntington Ingalls has a more volatile performance record than Northrop Grumman and Lockheed Martin. Nevertheless, the company has managed to grow its earnings per share by 15.4% per year on average over the last five years. In addition, it has promising growth prospects ahead thanks to the hefty spending of the Pentagon on nuclear submarines and amphibious assault ships. As a result, Huntington Ingalls is likely to return to its growth trajectory next year.

Final Thoughts

Competition has heated in almost every sector in recent years and hence it has become challenging for investors to stick to the buy-and-hold strategy. Defense stocks constitute a bright exception, as they have unparalleled expertise and hence there are very few players in this business, which share a large and growing pie. Northrop Grumman, Lockheed Martin, and Huntington Ingalls have rewarded their shareholders with double-digit annual returns over the last decade.

Even better, they are likely to continue offering high returns to their shareholders thanks to the above-mentioned growth drivers and their attractive valuation levels tight now.