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On the Dividend Trash Pile: Defense Stocks

Reuben is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Defense spending has been elevated over the last two presidencies because of a pair of wars. Where you stand on their popularity is virtually meaningless, however, as both wars look set to be “ended” by the end of Obama's next presidential term. Despite the fact that Obama could hardly be called a dove, he has expressed an interest in cutting defense spending.

There is a great deal of controversy surrounding cuts in defense spending, however, since many believe that a good offense starts with a good defense. Moreover, the upcoming spending cuts, which may have been misguidedly passed into law by a divided government, are massive and less than two months away. The size and scope of the so-called sequestration cuts has many worried about the ramifications.

The cuts to defense would be so painful for the U.S. military and the defense industry that most agree they are not likely to take place. Obama hinted as much in the presidential debates. Even if the cuts do take place, it is still unclear how they will impact industry participants, let alone U.S. defense capabilities as Obama looks to reshape the military in what he and his advisers believe is a more effective form to deal with today's potential military conflicts. 

Wall Street hates uncertainty and there is a good deal of it right now for the defense industry. Even if sequestration is avoided, there is a good likelihood that the industry will still see budget cuts. With that as a backdrop, however, military spending has waxed and waned through the years and it will never go away. So there is still some long-term promise for those that can survive the current cutting mood. Three companies that were hit by the post Obama reelection market selloff that are worth at least keeping an eye on are Lockheed Martin (NYSE: LMT), General Dynamics (NYSE: GD), and Raytheon (NYSE: RTN).

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LMT data by YCharts

All three have operations that span across the defense sector, including war vehicles, technology services and equipment, and space systems. Although each has different specialties, they compete against each other vigorously for the few large contracts that come from their main customer, the U.S. Government. Of the three, General Dynamics has the least exposure to the U.S. defense cuts, but it still derives well over 2/3 of its revenue from Uncle Sam. Of course, the defense industry is odd in that there are many incestuous relationships in the industry, where one company gets a large contract and hires competitors to help out. So a cut that may appear to impact one company may actually have much broader implications. That said, a contract that looks set to help one company may also have broader implications.

Of the three, Lockheed Martin is by far the largest. It also has the highest dividend yield. That said, for an investor seeking income and broad industry exposure, Lockheed is a great selection. Note that it has a history of regular annual dividend increases that is quite impressive, too. Raytheon has the next highest yield, and its battle field technology puts it in prime position to benefit from the shift toward a smaller, more agile military. The company's dividend disbursement has been increased regularly of late, but spent a few years stuck at $0.80 annually. General Dynamics, with the lowest yield of the three, has a corporate jet business that may help to soften the blow of any budget cuts. The company has a solid history of annual dividend increases.

Lockheed Martin's size and high yield likely make it the most interesting of the trio. However, all three are solid financially and should be able to weather the budget cuts that do take place. Moreover, since the United States isn't going to stop spending on defense altogether, being large in this industry may allow for opportunistic acquisitions if smaller companies falter after the budget pinch.

Indeed, keeping an eye on these three could be a good thing even if the immediate sell off after the election reverses somewhat. Until there is a budget resolve, volatility is likely to remain high. Still, uncertainty can be hard to deal with, especially if it involves price declines, so more aggressive income-oriented investors with an eye to the future should play here, others would likely be better served waiting for more industry clarity.

Yours,

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ReubenGBrewer has no positions in the stocks mentioned above. The Motley Fool owns shares of General Dynamics, Lockheed Martin, and Raytheon Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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