Enclosed are three Morningstar reports on Defense stocks. I believe that there are investment opportunities in this sector. Please allow me to explain why.
On August 2, the Budget Control Act of 2011 was signed into law by President Obama. This immediately increased the US debt limit by $400 billion and specified $917 billion of cuts over the next 10 years. Also, the bill created a “super committee” to determine another $1.2-1.5 trillion in cuts to be implemented over the next decade. If the committee cannot agree on a deal, automatic cuts, including $54 billion from the Pentagon’s 2013 budget, will be triggered[i]. With the defense budget projected to be $525 billion in 2012, this $54 billion cut would chop off 10.29 percent of its budget. Moreover, in April Obama proposed $400 billion in defense cuts over the next 12 years through savings from reductions in troops in Iraq and Afghanistan. However, it has been argued that by just holding the Pentagon’s budget at its current levels, $400 billion would be saved in inflation-adjusted terms[ii]. In this case, defense spending would decline in relation to GDP, but would remain at the same nominal level.
As a result of the uncertainty over the defense budget, our three highlighted stocks fell by an average of 9.68 percent over the past six months. They currently have a Price-to-Earnings ratio of 9.62, which is lower than the S&P 500 Index’s P/E ratio of 13[iii]. While the selloff and consequent valuation are results of the impending defense cuts, the uncertainty over the quantity of the cuts could create an opportune entry point for investors. When Obama was elected President at the end of 2008, defense sector stocks experienced large sell offs on fears that Obama and the Democrat-controlled Congress would decrease the defense budget significantly. In actuality defense spending increased and defense stocks rallied over 40 percent in just a few months. While it is likely that defense spending will be cut by 3-5 percent annually for the next decade, the selloff in defense stocks appeared to price in more drastic cuts than this. With a new emphasis on cyber security and international defense spending, these three defense stocks may be able to weather cuts in US conventional defense spending. Finally, the three stocks’ dividend yields range from 2.75-3.50%[iv]. Since each company currently has little debt on their balance sheets and pays out less than one-third of their earnings as dividends, their dividends should be safe even if their earnings decline gradually.
At Armstrong Advisory Group, we manage wealth for affluent and educated families. You will find three Morningstar research reports enclosed with this material, and please understand that we are not recommending all of these stocks today. We would like to extend to you the opportunity to have your current investment portfolio reviewed. During this review process we will help you determine if any of these three Defense stocks would be appropriate. Our minimum household account size is $250,000. Please call (800) 393-4001 if you would like to have your current investment portfolio reviewed. For our complete database of articles please go to www.armstrongadvisorygroup.com.
[i] Farrell Jr., Lawrence. Budget Control Act of 2011 Forces Real Cuts to Defense, and Difficult Choices. 1 Sept 2011. National Defense. 11 Oct 2011. http://www.nationaldefensemagazine.org/archive/2011/September/Pages/BudgetControlActof2011ForcesRealCutstoDefense,andDifficultChoices.aspx.
[ii] Mr. Obama’s Defense Cuts. 20 April 2011. The Washington Post. 11 Oct 2011. http://www.washingtonpost.com/opinions/mr-obamas-defense-cuts/2011/04/20/AFlMqNEE_story.html.
*Dividend yield investing may not be suitable for all investors. You should never invest solely on the basis of dividends. Higher dividends will result in lower retained earnings. Investments paying dividends do not carry lower risk. Dividend payments are not guaranteed by the issuing entity. The issuer can discontinue the dividend at any time. Dividend payments reduce the price of the security by the amount of the paid dividend.
Securities offered through Securities America Inc., Member FINRA/SIPC and advisory services offered through Securities America Advisors, Inc. Armstrong Advisory Group and the Securities America companies are unaffiliated. Representatives of Securities America, Inc. do not provide legal or tax advice. Please consult with a local attorney or tax advisor who is familiar with the particular laws of your state. 10/11
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