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Overview

Historically, American Aerospace and Defense companies have been highly sensitive to fluctuations in government defense expenditures. As Washington faces heavy scrutiny over its "Fiscal Cliff" negotiations, many defense companies who rely on the US government for a substantial amount of their revenue have been under pressure. The uncertainty surrounding spending cuts specifically in the Department of Defense has made investors uneasy. The below listed Aerospace and Defense stocks all trade below 11x estimated 2013 earnings and all have market capitalizations above $15 Billion. These stocks should benefit as investors see more clarity on government expenditures for 2013. This list is meant to be a base for further research.

General Dynamics (GD)

Market Cap: $23 Billion

2013 Estimated PE: 9x

Dividend Yield: 3.06%

General Dynamics, the Aerospace and Defense company, has traded sideways in the past year, in the face of uncertainties over the US budget for the 2013 year. Investors remain concerned as to how any potential spending cuts, particularly to the Department of Defense, could potentially affect General Dynamics. In 2011, the US Government accounted for 69% of General Dynamics' revenue. This uncertainty has put a cloud over the stock, and any clarity from Washington over the budget could affect the stock price. General Dynamics pays a dividend of over 3%. General Dynamics has significant business in both land and water based combat equipment, such as its shipbuilding segment.

Raytheon (RTN)

Market Cap: $19 Billion

2013 Estimated PE: 10.5x

Dividend Yield: 3.49%

Raytheon, another defense player, is experiencing similar headwinds to General Dynamics. However, Raytheon's stock price is up by nearly 25% in the past year. Similar to other defense plays, if investors receive clarity regarding the budget negotiations from Washington, these defense companies should benefit from the removal of the uncertainty currently experienced. This is significant because in 2011, 74% of Raytheon's revenues came from sales to the US Government. Raytheon does a significant trade in various types of missiles and missile defense systems and various radar systems.

Northrop Grumman (NOC)

Market Cap: $16 Billion

2013 Estimated PE: 9.6x

Dividend Yield: 3.27%

Northrop Grumman is more focused on Aerospace than the competitors mentioned earlier in this article. It is also a smaller company and trades for a similar earnings valuation. The stock has rallied 16% over the past year. In 2011, Northrop Grumman spun off its shipbuilding subsidiary, Huntington Ingalls Industries. As Northrop Grumman shed this low margin business, it has been able to have a greater focus on its Aerospace and Electronics businesses. Investors are also rewarded with a healthy dividend yield. In 2011, Northrop Grumman's sales to the US Government accounted for about 91% of revenue. This figure is above that of its peers and may leave Northrop Grumman over-exposed to any unanticipated defense budget cuts, but the company should benefit if the cuts come in less than expected.

Conclusion

In the coming weeks, the Aerospace and Defense sector will likely be driven by headlines from budget discussions with top political leaders, as they try to avoid the ill effects of the "Fiscal Cliff". The market is aware that there is the potential for a rather sizeable cut to defense spending which should hurt revenue potential for the sector as a whole. However, if there is clarity and news that the defense cuts will come in less than currently expected, these defense names should benefit. The next few weeks will be key for the sector, and there is the potential for added volatility.

Source: 3 Defense Companies To Buy Ahead Of A Fiscal Cliff Compromise