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There are four defense stocks that stand out as dividend stocks, and among which may be important winners or losers in a future with a scaled down U.S. defense budget.

Those companies are General Dynamics (GD), Lockheed Martin (LMT), Northrup Grumman (NOC) and Raytheon (RTN).

They are standouts as dividend stocks, among defense companies, on the basis of their status as constituents of several dividend stock indexes, and a rigorous quantitative screen that eliminates most other companies.

ETF Portfolio Constituents Test:

We cross referenced the most recently reported holdings of seven dividend ETFs: SDY, DVY, VYM, VIG, HDV, FVD and FDL. Of their holdings, there were 154 companies that were held by three or more of the funds.

The names and sponsors of the dividend ETF used are:

  • (SDY) S&P Dividend Aristocrats (sponsored by SPDRs)
  • (DVY) Dow Jones Select Dividend index (sponsored by iShares)
  • (VYM) FTSE High Dividend Yield Index (sponsored by Vanguard)
  • (VIG) Vanguard/Mergent Dividend Achievers Select Index (sponsored by Vanguard)
  • (HDV) Morningstar Dividend Yield Focus Index (sponsored by iShares)
  • (FVD) Value Line Dividend Index (sponsored by First Trust)
  • (FDL) Morningstar Dividend Leaders (sponsored by First Trust)

Quantitative Criteria Test:

We then subjected that list of 154 to this set of quantitative screening criteria:

  • price >= $5
  • market-cap >= $250 million
  • average per minute dollar trading volume >= $25,000
  • current yield >= 3%
  • dividend paid in each of last 6 years
  • dividend not decreased in any year
  • dividend TTM >= dividend prior TTM
  • 5-yr dividend growth rate >= 3%
  • 5-yr sales growth rate >= 3%
  • cash flow from operations TTM > 0
  • dividends paid TTM <= cash flow from operations TTM
  • dividends paid past 5 years <= cash flow from operations past 5 years

That quantitative screen reduced the stocks list to 15 from 154. Of that, 15 were the 4 defense stocks.

Weighting In Defense ETFs:

Those four stocks in combination represent about 20% of the assets of ITA and PPA, two defense ETFs.

Theme - Changed Nature of Warfare:

Everything is up for grabs these days, with extremely high uncertainty about the federal budget and defense allocations.

We believe, however, that some broad allocation principles are likely to evolve.

There is likely to be less emphasis on weapons, systems and manpower for large scale conventional wars between nations; and more emphasis on weapons, systems and manpower for intelligence, counter-terrorism, cyber warfare and technological weapons.

Global conflict between major nations with conventional weapons through professional land, sea and air forces is less likely, while regional or local conflicts involving weak, failing or failed states, or non-state groups is more likely.

The Internet and outer space are of growing importance as battlefields or attack launch areas, in addition to traditional land, sea and air.

Intelligence functions increasingly rely on technology to gather and process information, as well as to detect, observe and track adversaries.

Soldiers on the ground are increasingly technology laden to effectively handle operations in unfamiliar territories where they are typically outnumbered by the adversary.

The recent successful use of drones (unmanned aerial vehicles) is an example of unconventional warfare that is likely to increase at the expense of military aircraft with a pilot in the cockpit. Drones cost less to build than a manned vehicle, and can be turned out in quantity comparatively rapidly, while effective pilots cannot.

Various forms of electronic intelligence, cyber defense and attack capabilities will probably grow, while the number of men and women in uniform may not.

These similar sub-themes keep reshaping the weapons and systems that make for a superior warfare capability, and that keeps reshaping which defense contractor are at the right spot for the defense dollar allocation.

Those defense contractors most capable of competing for the high tech non-conventional weapons and systems will probably benefit the most in the coming defense budget environment. Those with the largest dependence on conventional weapons and systems will probably have the most difficulty maintaining revenue growth.

The four defense contractors each have a segments of their business in the conventional and unconventional weapons and systems arena.

How they manage to adapt through upsizing and downsizing business units, and acquiring and divesting business units, will determine which come out on top as stock investments.

We don't have an answer to the question of which will do best, but as dividend oriented investors, we believe that these four deserve particular observation in terms of how they position themselves for the decade ahead.

There's a long way between now and resolution of the matter, but we tend to think that Northrup Grumman and Raytheon are better positioned for the probable new budget realities than General Dynamics and Lockheed Martin.

The likely allocation shift from conventional defense contract needs to new world, unconventional defense contracts, of course, opens up special opportunities for smaller companies and those not engaged in traditional weapons and systems.

However, for dividend investors, the larger defense contractors are more in focus.

Business Descriptions (from Yahoo Finance):

General Dynamics

General Dynamics Corporation provides business aviation, combat vehicles, weapons systems and munitions, military and commercial shipbuilding, and communications and information technology products and services worldwide. Its aerospace group offers mid-size and large-cabin business-jet aircraft, and provides maintenance, refurbishment, outfitting, and aircraft services for business-jet, narrow-body, and narrow-body customers. The company's Combat Systems group designs, develops and produces tracked and wheeled military vehicles, weapons systems, and munitions. Its product lines include wheeled combat and tactical vehicles; battle tanks and infantry vehicles; munitions and propellant; rockets and gun systems; and drivetrain components and aftermarket parts. This group also manufactures and supplies engineered axles, suspensions, and brakes for heavy-load vehicles for military and commercial customers. The company's Marine System group designs, builds, and supports submarines and surface ships for the U.S. Navy; and Jones Act ships for commercial customers. This group offers nuclear-powered submarines, surface combatants, and auxiliary and commercial ships; and provides design and engineering support services, as well as ship and submarine overhaul, repair, and lifecycle support services. Its Information Systems and Technology group provides technologies, products, and services that support a range of government and commercial communication and information-sharing needs, including communications systems, command-and-control systems, and operational hardware; information technology services; and intelligence, surveillance, and reconnaissance systems to the U.S. Department of Defense, the Department of Homeland Security, intelligence community, federal civilian agencies, intelligence and homeland security communities, and commercial and international customers.

Lockheed Martin

Lockheed Martin Corporation engages in the research, design, development, manufacture, integration, operation, and sustainment of advanced technology systems and products in the areas of defense, space, intelligence, homeland security, and government information technology in the United States and internationally. It also provides management, engineering, technical, scientific, logistic, and information services. The company operates in four segments: Aeronautics, Electronic Systems, Information Systems & Global Services (IS&GS), and Space Systems. The Aeronautics segment offers military aircraft, including combat and air mobility aircraft, unmanned air vehicles, and related technologies. Its products and programs comprise the F-35 multi-role, stealth fighter; the F-22 air dominance and multi-mission stealth fighter; the F-16 multi-role fighter; the C-130J tactical transport aircraft; and the C-5M strategic airlifter modernization program; and support for the P-3 maritime patrol aircraft, and the U-2 high-altitude reconnaissance aircraft. The Electronic Systems segment provides air and missile defense; tactical missiles; weapon fire control systems; surface ship and submarine combat systems; anti-submarine and undersea warfare systems; land, sea-based, and airborne radars; surveillance and reconnaissance systems; simulation and training systems; and integrated logistics and sustainment services. The IS&GS segment offers information technology solutions and advanced technology primarily in the areas of software and systems integration for space, air, and ground systems to various defense and civil government agencies. The Space Systems segment provides government and commercial satellites; strategic and defensive missile systems, including missile defense technologies and systems, and fleet ballistic missiles; and space transportation systems.

Northrop Grumman

Northrop Grumman Corporation provides products, services, and solutions in aerospace, electronics, information systems, shipbuilding, and technical service sectors. Its Aerospace Systems segment offers manned and unmanned aircraft, spacecraft, high-energy laser systems, microelectronics, and other systems and subsystems in the areas of intelligence, surveillance, and reconnaissance; communications; battle management; strike operations; electronic warfare; missile defense; earth observation; space science; and space exploration. The company's Electronic Systems segment provides defense electronics and systems, airborne fire control radars, situational awareness systems, early warning systems, airspace management systems, navigation systems, communications systems, marine systems, space systems, and logistics services for military, civil, and commercial customers in the United States and internationally. Its Information Systems segment offers products and services focusing on the fields of command, control, communications, computers, and intelligence; air and missile defense; airborne reconnaissance; intelligence processing; decision support systems; cybersecurity; information technology; and systems engineering and integration. This segment serves the Department of Defense, national intelligence, federal civilian, state and local agencies, and commercial customers. Its Technical Services segment provides logistics, infrastructure, and sustainment support services, as well as technical services, including training and simulation.

Raytheon

Raytheon Company, together with its subsidiaries, provides electronics, mission systems integration, and other capabilities in the areas of sensing, effects, and command, control, communications, and intelligence systems, as well as mission support services in the United States and internationally. It operates in six segments: Integrated Defense Systems, Intelligence and Information Systems, Missile Systems, Network Centric Systems, Space and Airborne Systems, and Technical Services. The Integrated Defense Systems segment provides integrated naval, air, and missile defense and civil security response solutions. The Intelligence and Information Systems segment offers intelligence, surveillance and reconnaissance, advanced cyber solutions, weather and environmental solutions, and information-based solutions for law enforcement and homeland security. The Missile Systems segment develops and produces weapon systems, including missiles, smart munitions, close-in weapon systems, projectiles, kinetic kill vehicles, and directed energy effectors for the armed forces of the U.S. and other allied nations. The Network Centric Systems segment provides net-centric mission solutions, including integrated communications systems, command and control systems, combat systems, and operations and precision components for the U.S. federal, state, and local government customers, as well as civil customers. The Space and Airborne Systems segment designs and develops integrated systems and solutions for missions, including intelligence, surveillance, and reconnaissance; precision engagement; unmanned aerial operations; and space. The Technical Services segment provides training, logistics, engineering, product support, and operational support services for the mission support, homeland security, space, civil aviation, counterproliferation, and counterterrorism markets.

Stock Charts

The following charts compare the four defense contractors to each other and to the S&P 500 (proxy SPY) on a percentage performance basis for 10 years monthly, 3 years weekly, and 3 months daily.

Click to enlarge

Securities Identified In This Article: GD, LMT, NOC, RTN, SPY, SDY, DVY, VYM, VIG, HDY, FVD, FDL, ITA, PPA.

Disclosure: QVM does not have positions in any mentioned security as of the creation date of this article (November 9, 2011).

Disclaimer: This article provides opinions and information, but does not contain recommendations or personal investment advice to any specific person for any particular purpose. Do your own research or obtain suitable personal advice. You are responsible for your own investment decisions. This article is presented subject to our full disclaimer found on the QVM site available here.

Source: 4 Dividend Income Defense Stocks And Their Future In A Scaled Down Defense Budget