Memorial Day is a time to reflect on the men and women who have served and sacrificed their lives for our country.
For stock market denizens, Memorial Day is also a chance to reflect on the defense industry that supplies our armed services and the prospect for future returns.
Defense, it turns out, is a Wall Street darling. The average buy rating ratio—which is buy recommendations divided by total recommendations—for the Dow Jones Industrial Average is about 55%. The average buy rating ratio for defense stocks is closer to 70%.
Analysts agree the outlook is bright for the defense sector. Wall Street might prefer defense these days because U.S. military spending is growing and industry fortunes aren’t tied to the health of the overall economy.
As is the case with any industry, there are favorite stocks within the sector. Wall Street’s six highest-rated defense stocks are: Curtiss-Wright (ticker: CW), Leonardo (LDO.Italy), Northrop Grumman (NOC), General Dynamics (GD), Parson (PSN) and BAE Systems (BA.London).
Curtiss-Wright traces its heritage back to the Wright brothers. It sells components and services to other aerospace suppliers as well as the Defense department. Leonardo traces its name back to da Vinci and makes helicopters, aerospace structures and other products. Northrop makes the famous stealth bomber. General Dynamics, in addition to defense, makes private jets. BA Systems is a large defense conglomerate making aircraft, avionics, radar equipment and weapons. Parsons, the lesser know defense name, specializes in cybersecurity. More than 40% of its sales come from the defense department.
Valuation is another reason for Wall Street’s buy ratings on these stocks. The six stocks trade for an average of about 13 times estimated 2021 earnings, a discount to other defense stocks and the broader market.
What’s more, it looks like now might be a good time to get into the sector. The six stocks are down about 20% year to date, trailing behind the market. In fact, all defense stocks are down about 14% year to date.
Defense stocks’ exposure to aerospace might be a reason for the larger-than-average declines. Covid-19 has decimated demand for commercial air travel. People flying commercial in the U.S. fell more than 90% year over year in April. But these six companies spend most of their time servicing defense end markets.
Still, it’s worth asking: Should anyone listen to Wall Street? It turns out Wall Street does a decent job of picking stocks. Looking back, stocks in the S&P 500 that Wall Street liked one year ago have lost about 2% since. Stocks Wall Street panned one year ago are down about 4% since. Even in the midst of the coronavirus pandemic, Wall Street’s picks performed a little better than the stocks analysts were more cautious about.
How can both the average return for stocks Wall Street likes and doesn’t like be negative—especially if the total return for the S&P 500 index is about 7% over the past year? The S&P is a market capitalization weighted index. The strange results reflect the fact that most of the gains are accruing to a small number of large stocks.
Apple (AAPL), for instance, is large and its shares are up about 80% over the past year. Apple is an interesting case. It shows Wall Street doesn’t always get it right. Analyst didn’t like Apple stock one year ago. They did, however, like Microsoft (MSFT). That stock is up almost 50% over the same span.
As a reminder, a stock screen is not a stock pick. But it is a useful place to start your research.
Have a safe and happy Memorial Day. Analysts and investors will get back at it on Tuesday.
Write to Al Root at firstname.lastname@example.org