Investors got a jolt back to reality about the volatile geopolitical landscape after the Hamas attacks on Israel. When the news broke, the best defense stocks rallied. However, despite those gains, most defense stocks are still underperforming the S&P 500 year-to-date.
First, the Russian-Ukraine war has triggered an increase in defense spending worldwide. Notably, military spending hit record highs in 2022, fueled by European spending. After years of underinvestment, these nations recognized the risks and increased spending by 13%.
Secondly, the United States and several European nations have provided Ukraine with substantial military equipment and weaponry aid. Therefore, they must replenish their inventory from now on, providing a revenue tailwind for defense stocks. Furthermore, Ukraine still needs critical arms to continue its resistance against the Russian invasion.
Given the geopolitical landscape, there has never been a better time to buy the top defense stocks. Military budgets in the U.S. and among its allies are rising. Here are some of the best defense stocks that are undervalued.
Lockheed Martin (LMT)
A Lockheed Martin (LMT) Space Systems sign in Sunnyvale, California.
Source: Ken Wolter / Shutterstock.com
This defense contractor is famous for its F-35 fighter jets. Indeed, today, Lockheed Martin’s (NYSE:LMT) fighter jets are an integral part of Israel’s defense operations as it pursues Hamas and defends itself. Over the next decade, the company will benefit from increasing military budgets.
With conflicts in the Middle East and Ukraine as well as a looming China-Taiwan war, its technologies have never been more critical. Its fighter jets, mainly the F-35, are crucial to deter enemy combatants and take offensive actions.
The F-35 program is the largest revenue source, accounting for 27% of total sales. Additionally, the company sells air and missile defense systems, helicopters and satellite defense systems.
Amidst the elevated global tensions, backlog was $156 billion by the end of third quarter of fiscal year 2023. In addition to the U.S., allies like Denmark, Czech Republic and South Korea are signing up for F-35 jets. In July, Israel approved an additional purchase of 25 F-35s, bringing its total fleet to 75.
Another big win for Lockheed came in August when it was selected as a strategic partner for Australia’s Air 6500 program Phase 1. Using its proven technology, the company will help connect Australian defense systems and platforms that operate across air, space, land, sea and cyber domains.
Over the past two decades, Lockheed Martin has been central to U.S. and allied defenses. Notably, this relationship has provided a steady source of revenues and hence shareholder returns.
Notably, Lockheed has spent $26.6 billion on buybacks and paid $23 billion in dividends over the last ten fiscal years. Year-to-date, it has generated $4.5 billion in free cash flow and returned $2.2 billion in dividends and $3 billion in repurchases. Buy one of the best defense stocks today for growth and increasing shareholder returns.
L3Harris Technologies (LHX)
An office building with the logo for L3Harris Industries visible on the building.
Source: JennLShoots / Shutterstock.com
According to Raymond James, L3Harris Technologies (NYSE:LHX) is one of the most undervalued defense stocks. On October 30, the firm upgraded the stock to “outperform,” setting a price target of $210. After underperforming peers due to under-earning, the company will close the gap as earnings normalize.
The company is now in the fifth year of the merger between L3 and Harris. Despite the earlier challenges in merger integration, the company is finally returning to solid execution. Now, with the combination, it can compete with other large defense primes.
Amidst the geopolitical conflicts, L3Harris is proving to be a crucial defense supplier to deter aggression. The U.S. and its allies rely on its intelligence, surveillance and reconnaissance systems. These capabilities support departments like the U.S. Air Force and Navy.
The company also provides avionic systems and advanced wireless and cyber solutions for defense and intelligence customers. Additionally, the company offers tactical communications to defense customers.
Besides improvement in the traditional defense business, the recently closed Aerojet Rocketdyne acquisition will be an earnings driver. Already, Aerojet has won $200 million in awards from the Defense Production Act this year. Moreover, management expects $40 to 50 million in cost savings.
Regarding overall results, L3 Harris is experiencing robust top-line growth, achieving 16% growth in the latest quarter. For the full fiscal year 2023, management expects to deliver double-digit growth supported by demand from the Department of Defense and international. At 15 times forward earnings, LHX stock is one of the best defense stocks to buy.
Kratos Defense & Security Solutions (KTOS)
The front of a Kratos (KTOS) office in Silicon Valley.
Source: Michael Vi / Shutterstock.com
Given the secular tailwinds, Kratos Defense & Security Solutions (NASDAQ:KTOS) might be one of the best defense stocks to buy. Demand for unmanned systems is soaring, driving up the company’s revenues.
As the third quarter results revealed, the firm is seeing healthy demand. Revenue growth accelerated to 20% YOY compared to 14.5% in the second quarter. The company is benefiting from increased target drone-related activity. As of October 1, it had a funded backlog of $850.9 million and an unfunded backlog of $314.1 million.
Looking at segment performance, Government Solutions Segment reported $217.9 million in revenues, a 22% organic growth. Sales increased across Space, Satellite and Cyber, C5ISR, Microwave Electronics Products, Turbine Technologies and Training Solutions businesses.
On the other hand, the Unmanned Systems Segment (KUS) saw 13.4% growth. This segment will drive growth from now on. Its revenues for the quarter were only $56.7 million, but significant growth lies ahead. The total backlog for the segment was $227.8 million at the end of the quarter.
Overall, management is optimistic and has increased FY2023 guidance. Additionally, they expect 10% revenue growth in 2024 after excluding tactical drone production orders. With a total funded backlog of $850.9 million, management expects a solid 2024. With increased use of unmanned systems in wars, Kratos is one of the best stocks to buy.
On the date of publication, Charles Munyi did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Charles Munyi has extensive writing experience in various industries, including personal finance, insurance, technology, wealth management and stock investing. He has written for a wide variety of financial websites including Benzinga, The Balance and Investopedia.
