How to Invest in Defense and Aerospace Stocks

The defense industry produces modern weaponry, including combat vehicles, ships, bombers, and fighter jets. Companies in the industry also offer cybersecurity, information technology (IT), analytics, robotics, and intelligence systems. The majority of defense industries' revenue comes from a single customer: the United States government. Fortunately, that customer is well-heeled and has a 246-year track record of paying its payments on time. When it comes to military spending, it spends significantly more than any other country. It has a $778 billion expenditure, whereas China which follows it, has a $252 billion budget.

Trends in defense

Focus on technology

Years back, the only firms on the planet capable of producing enormous battleships, bombers, and tanks were the main competence in the defense and aerospace industry. However, things have changed; the value is increasingly flowing to the corporations who offer the brains that go inside it, rather than the companies that forge the steel. 

Electronic warfare and defense electronics are becoming an increasingly important part of practically every company's business. It's where a lot of internal investment is now focused. Defense IT is still a top focus, with manufacturers striving to equip the Pentagon with secure networks and data-rich communications systems.

Biden claimed he would move the budget from old systems that won't be relevant to wise investments in technology and breakthroughs — including cyber, space, unmanned systems, and artificial intelligence to deter Russia and China on a budget. When looking for an excellent stock or ETF to invest in, make sure it has the most up-to-date technology.

US change in administration

Donald Trump, the former US president, increased military spending because of tension with China and the Middle East. In 2020, analysts expected this spending to be slashed as a new administration was ushered in. However, when Biden took the POTUS seat in 2021, his first Department of Defense budget remained largely unchanged. Because of his renewed focus on modernization and research, military spending might rise in the following years, guaranteeing the major contractors in the field a steady revenue stream.

Defense is frequently associated with current events by investors. However, given the long lead periods for programs and the widespread support for military spending, you can concentrate on selecting the best-run defense companies.

Increased tension from around the world

Currently, the US and its NATO allies are facing increased tension in areas like Russia and several other regions all over the world. If any of these conflicts turn into full-scale war, the US may see increased demand for ammunition and other war paraphernalia. However, this is not enough reason to rush into investing in defense stocks and ETFs.

Military contractors get most of their revenue from the research and development of new, modernized war equipment rather than supplying their troops and war efforts on the ground. If the US was to lay more emphasis on this supply and reduce spending on research, it could drive down the value of these stocks. However, given the importance of research and the role it has played in winning them previous wars, this is unlikely to be their course of action. 

How do you identify top defense and aerospace stocks and ETFs? 

Keep an eye on the customers

Pay close attention to each customer's budgeting process. The Pentagon, for example, has an insatiable desire for new technology, yet new equipment is expensive, and the government's purchasing power is limited.

An investor should review the budget proposal, which is published on the Pentagon's website, as well as other commentary, to see which initiatives are a top priority for the administration.

The Pentagon submits a financial proposal to Congress early in the year, and Congress holds hearings throughout the spring and summer to examine priorities and make final allocation decisions.

Pay attention to the numbers

Defense companies make the necessary data public in quarterly earnings reports or conference calls. Pay close attention to the following key metrics when you want to invest.

Cash flow: Depending on whether a defense contractor's project is new or well-established, this might differ. In the early phases of a manufacturing contract, companies frequently spend more, thus reducing cash flow.

Corporate backlogs: These are contracts that have been awarded but have yet to be fulfilled. How much of the backlog has been financed and how much still has to go through the budgeting process in Congress can be very different.

Book-to-bill ratio: This indicator reveals a company's growth potential by comparing the value of orders received in a given quarter to the amount billed. A growing firm should have a ratio of at least 1.0, indicating that future product orders are being booked at a pace that equals or surpasses what is currently being supplied.

Top defense stocks

Textron: It works on military and commercial aircraft, munitions, leisure vehicles, and engines, among other things.

L3Harris Technologies: A combination between L3 Technologies and Harris Corp resulted in the formation of the corporation. As a result, the new corporation became the US government's sixth-largest military contractor.

Boeing: This is a firm known for its massive commercial planes, but contracts with the US military account for a significant portion of its annual earnings.

Top defense ETFs

ITA: Due to the frequent usage of long-term government contracts for the majority of their services, companies in this industry tend to be very big, slow-growing, but extremely stable.

ARKX: It's an actively managed fund that invests in worldwide space exploration and innovation enterprises. Enterprises that create technologies for space exploration, as well as orbital and suborbital aerospace companies, are included in the portfolio.

DFEN: The Direxion Daily Aerospace & Defense Bull 3X Shares seeks to triple the daily return of an index of defense firms such as Boeing, United Technologies, Lockheed Martin, and Raytheon.

Summary

Investing in defense and aerospace stocks and ETFs needs in-depth research. The trends to keep an eye on include technology, change of administration, i.e., US government, and tension around the world. Also, look at each customer's budgeting process and the earning reports, which are released quarterly.