Seeking Alpha
Profile| Send Message| ()  

With the conflict in Gaza escalating, the world has once again turned its attention to military action. As investors, it is normal to look for opportunity in the midst of chaos and defense stocks are beginning to once again grab the eyes of traders. It’s not just the Middle East that should be turning heads, but also conflicts between Russia and the Balkans, (natural gas is actually one of the tools of warfare). My friend Justice Litle, Editorial Director for the Taipan Publishing Group, also noted that things have been unusually quiet in North Korea as well. Is it out of the question that we could face a serious, multi-county conflict in 2009?

While I certainly do not relish the thought of armed conflict and civilians in danger, it’s important to protect ourselves both physically and fiscally if such an event were to arise. And so investors should certainly keep an eye on stocks that will do well if conflict intensifies. The natural tendency is to flock to stocks like Northrop Grumman (NOC) Lockheed Martin (LMT) and General Dynamics (GD). These large-cap players have actually held up fairly well during the fist week of trading this year.

As usual, my focus is on the smaller growth stocks in the area which have more potential for doubling or tripling my investment. One of the most exciting names that I have come across is AeroVironment Inc. (AVAV). The company has many innovative solutions for civilians as well as military, but it is especially well known for its unmanned aircraft which can be launched by hand. The airplanes are small enough to be carried onto the battlefield and yet still carry sophisticated camera and data capture equipment. If a convoy needs to see what is behind the next ridge or in the next valley, they just launch the plane and take a look.

The stock is a bit expensive at this level (trading at roughly 30 times earnings) and so it appears a bit dangerous to buy at the current level. But with so much innovation and a strong list of prototypes, it could be that analyst estimates for future earnings are too conservative. Keep your eye on this name for opportunities to pick up stock on a dip.

Its no wonder governments are turning to technology to fulfill their military needs. Since recruiting has become difficult for some countries, defense departments are finding themselves with the need to do more with less. The US military contracts with thousands of small companies to provide the innovative solutions to compete in this ever changing environment. Despite advantages that large companies have in this sector (capital to hire lobbyists, inside contacts in the Pentagon) the military actually has a vested interest in keeping small companies in business. This is because the niche manufacturers will be able to continue to service their products and hopefully continue to innovate in order to improve performance.

Since most military contracts rely more on quality of work than on price, the margins can be quite good in this business. Also, the US military is often viewed as a primary outlet for new technology, while other countries can be a secondary source of income, buying proven products and services for years afterwards. So with such strong profitability and a few large stable customers, it makes sense for investors to be aware of defense stocks in 2009.

avav-chart.JPG

AVAV Notes

Disclosure: Author does not have a position in any stocks mentioned.

Source: AeroVironment: Time for Defense Stocks to Gear Up