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The dividends being paid by defense stocks aren’t eye-popping. But given the long-term return potential of these stocks, investors should be buying defense dividends.
I’ve covered the defense industry in the past, noting that perpetual unrest around the world (referring to the turmoil in Iraq at the time) continues to drive defense spending higher. My colleague, Larry Meyers, has also been vocal about the benefits of the defense industry.
Even as the U.S. removes troops from the Middle East, there will be a serious need to replace and repair equipment.
Yet, the defense industry remains an underrated part of the investment community. Budget sequestration scared a lot of people out of the defense industry a couple years ago, but it has had little impact on the longer-term performance of these stocks.
The return for the Dow Jones U.S. Aerospace & Defense Index over the last three years is close to the return for the Dow Jones Industrial Average.
And the industry should remain a steady performer as the U.S. (and many other countries) continue to funnel money into their defense programs. The tragedy in Paris last week should serve as a reminder that there will always be a need for national security.
Without further ado, here are the top five defense stocks to own:
Defense Stock No. 1: Lockheed Martin Corporation (NYSE: LMT)
Lockheed Martin is the world’s largest military contractor. Its prized product remains the F-35 fighter jet. Toward the end of last year, Lockheed upped its quarterly dividend by 13% to $1.50 a share. It’s now paying the highest dividend of all five of our defense dividends, coming in at 3.1%. Lockheed Martin has upped its dividend for 12 straight years now.
Defense Stock No. 2: Raytheon Company (NYSE: RTN)
Raytheon is the sixth-largest military contractor in the world. Its specialty is in electronics, radar systems and high-tech missiles. And this just so happens to be an area where international companies are boosting spending in an effort to build out their defense systems. Think the Middle East and Asia.
It offers a solid 2.2% dividend yield and has upped its dividend for 10 straight years. Plus, its dividend payout ratio is just 35%.
Defense Stock No. 3: United Technologies (NYSE: UTX)
United Technologies is by far the largest company on our defense dividend list, with a $100 billion market. Yet, it’s not as “defense”focused as the other names. Its business includes military helicopters, as well as refrigeration solutions, elevators/escalators (via Otis) and aircraft engines (via Pratt & Whitney).
United Technologies pays a 2.1% dividend yield and despite paying a dividend for 44 years, it only has a three-year streak of consecutive dividend increases.
But it’s also been a big laggard in the industry, with shares up just 2% over the last 12 months.
Defense Stock No. 4: Northrop Grumman Corporation (NYSE: NOC)
Northrop Grumman is the third-largest military contractor in the world and is heavily tied to the defense industry. It specializes in information systems, which includes cyber security and missile defense systems.
Its yield is 1.8%, but its payout ratio is just 30%. It’s worth noting that Northrop Grumman has upped its dividend for seven straight years now.
Defense Stock No. 5: General Dynamics (NYSE: GD)
General Dynamics is the fourth-largest military contractor in the world and is also the second-largest maker of corporate jets.
While General Dynamics offers one of the lowest dividend of our five defense dividends, if all goes as planned, it’ll be the next company in the S&P 500 added to the list of Dividend Aristocrats. The company pays a 1.8% dividend yield, but has upped its dividend for 23 consecutive years.
Defense Stocks: The Bottom Line
So, which defense dividends should you own?
The five companies above all generate double-digit returns on invested capital, most of them between 13% and 14%. But Lockheed is a big outlier — generating an ROIC of 30%. In fact, it’s one of the best performing defense contractors across the board, with its stock up 35% over the last 12 months.
But trading at a price-to-earnings ratio of 20, Lockheed Martin isn’t the cheapest of our defense dividends. Rather, the value play of the industry is Raytheon, trading at a price-to-earnings ratio of 16.5. It also has one of the best balance sheets in the industry, with enough cash on hand to cover 12% of its market cap.
Or, you could always choose to go the way of ETFs. The largest ETF in the defense space is the iShares Dow Jones US Aerospace & Defense ETF (NYSEArca: ITA). The top three holdings make up nearly a quarter of the ETF’s portfolio—which includes United Technologies, Boeing (NYSE: BA) and Lockheed Martin.
However, the ETF offers a dividend yield of just 1.2%, while all five of our defense dividends yield 1.8% or higher. And over the last one- and three-year periods, every stock has outperformed the ETF, except United Technologies.
In closing: Regardless of the path you take, it pays to allocate part of your portfolio to the defense space. Staying defensive (read: owning dividend paying stocks in the defense industry) is a solid way to outperform the market on a multi-year basis.
Dividends for Every Month of the Year
If you’re looking for just one dividend stock to round out your income stream, consider a little-known company that pays out dividends 12 months of the year. Click here to see the full details of this company in my Dividend Calendar…