Protect Your Portfolio With Aerospace & Defense Stocks

With heightened geopolitical conflicts in multiple regions of the world, increased defense spending should be expected in response to potential security threats. This week, we use AAII’s A+ Investor Stock Grades to provide insight into three aerospace and defense stocks: Embraer S.A. (ERJ), Huntington Ingalls Industries Inc. (HII) and Optex Systems Holdings Inc. (OPXS).

Defense Stocks Recent News

Defense stocks have been in the news this week, as the world is dealing with external pressures driven by the deadly Israel-Hamas war, along with the continuing conflict between Russia and Ukraine. While a peaceful resolution is the universally desired outcome, defense spending is unfortunately still considered a necessity for most major players in the global economy.

The rising geopolitical tension caused by the war is already having an impact on the energy and commodities markets, as the southern Mediterranean Sea is a major shipping route between Europe, the Middle East and Asia.

Defense stocks surged and outperformed the S&P 500 index on Monday as the war caused concerns about global economic volatility. Major defense stocks added more than $23 billion in market capitalization. How this event is going to affect the market in the short term and over the long term is unclear, only time will tell.

Grading Defense Stocks With AAII’s A+ Stock Grades

When analyzing a company, it is helpful to have an objective framework that allows you to compare companies in the same way. This is why AAII created the A+ Stock Grades, which evaluate companies across five factors that have been indicated by research and real-world investment results to identify market-beating stocks in the long run: value, growth, momentum, earnings estimate revisions (and surprises) and quality.

Using AAII’s A+ Stock Grades, the following table summarizes the attractiveness of three defense stocks — Embraer, Huntington Ingalls Industries and Optex Systems — based on their fundamentals.

AAII’s A+ Stock Grade Summary for Three Defense Stocks

What the A+ Stock Grades Reveal

Embraer S.A. (ERJ) is a Brazil-based aircraft manufacturer. The company manufactures products for commercial and executive aviation, as well as for defense, security and related services. The company’s commercial aviation segment involves the development, production and sale of commercial aircraft and the rendering of support services, particularly in the regional aviation segment of aircraft leases. The Embraer Executive Jets division markets its executive jets to companies — including companies with fractional ownership — charter and air-taxi companies, high-net-worth individuals and flights academies. The defense and security business segment conceives, designs, develops and supports a range of solutions for the defense and security market. Lastly, the other related services segment provides fuel systems, structural parts and mechanical and hydraulic systems to Sikorsky Aircraft Corp. for its production of helicopters.

Embraer has a Value Grade of B, based on a score of 73, which is good value. The Value Score is the average percentile rank of the percentile ranks of the price-to-sales (P/S) ratio, price-earnings (P/E) ratio, the ratio of enterprise value to earnings before interest, taxes, depreciation and amortization (EBITDA), shareholder yield, price-to-book-value (P/B) ratio and price-to-free-cash-flow (P/FCF) ratio. The score is variable, meaning it can consider all six ratios, or if the values of the ratios are not valid, it measures those that are valid.

The company’s enterprise-value-to-EBITDA ratio is 6.7, below the sector median of 11.4. The price-to-sales ratio is 0.51, also below the sector median of 1.28. The company only has one null value for the price-earnings ratio.

Embraer has a Momentum Grade of B, based on a score of 79, which is strong. Momentum is based on the price change of a stock over a specified period relative to all other stocks. It is considered to be an anomaly in the analysis of stock returns because stocks with high relative levels of momentum have a pattern of outperforming, while stocks with low relative levels of momentum have a pattern of underperforming.

Embraer has an Earnings Estimate Revisions Grade of B, based on a score of 63, which is positive. The Earnings Estimate Revisions Grade is based on components that examine the magnitude of a company’s earnings surprises for the last two reported fiscal quarters as well as the change in the consensus estimate for the current fiscal year over the last month and three months.

Huntington Ingalls Industries Inc. (HII) is engaged in building and delivering naval ships and technologies for sea, sky, land, space and cyberspace. It operates through three segments: Ingalls, Newport News and mission technologies. The Ingalls segment designs and constructs non-nuclear ships for the U.S. Navy and Coast Guard, including assault ships, expeditionary warfare ships, surface combatants and national security cutters. The Newport News segment is involved in designing and constructing nuclear-powered aircraft carriers and submarines. The last segment, mission technologies, is engaged in providing mission-based solutions, unmanned systems, fleet support systems and services and nuclear and environmental services. It conducts its business with the U.S. government, specifically the Department of Defense (DOD).

Huntington Ingalls Industries has a Growth Grade of A, with a score of 97, which is very strong. The Growth Score considers a company’s success in growing sales on a year-over-year and long(er)-term annualized basis and its ability to consistently generate positive cash from its core operations. The five-year sales growth score looks at a company’s percentile ranking for its annualized growth in sales over the past five years. Sales have been growing by an average of 7.5% per year over the last five years. This ranks in the 87th percentile among all U.S.-listed stocks and is slightly above the sector median of 7.4%.

Huntington Ingalls Industries has a Momentum Grade of C, with a score of 52, which is average. The Momentum Grade is based on the price change of a stock over a one-year period, creating a weighted average of relative strength over each of the past four quarters. The most recent quarterly price change is given a weight of 40%, and each of the three previous quarters are given a weight of 20%. Huntington Ingalls Industries has a weighted relative price strength of –5.0%, which is below the sector median of –2.1%.

Huntington Ingalls Industries has a Quality Grade of B, based on its Quality Score of 72, which is strong. The Quality Grade is the percentile rank of the average of the percentile ranks of the return on assets (ROA), return on invested capital (ROIC), gross profit relative to assets, buyback yield, change in total liabilities to assets, accruals, Z double prime bankruptcy risk (Z) score and F-Score. Stocks receive better grades for having higher scores for the quality subcomponents and worse grades for lower scores. Huntington Ingalls Industries’ change in total liabilities to assets is –3.9%, which is lower than the sector median of 1.0%. The return on assets is 4.8%, above the sector median of 2.9%.

Optex Systems Holdings Inc. (OPXS) is a manufacturer of optical sighting systems and assemblies, primarily for the DOD. Its products are installed on various types of U.S. military land vehicles, such as the Abrams and Bradley fighting vehicles, armored security vehicles and the Stryker family of vehicles. The company’s segments include Optex Systems and Applied Optics Center. It also manufactures and delivers several periscope configurations, rifle and surveillance sights and night vision optical assemblies. It provides its products both directly to the federal government and to prime contractors. The company’s products primarily consist of build-to-customer print products that are delivered both directly to armed services and to other defense prime contractors.

Optex Systems has a Growth Grade of B, based on its score of 75, which is strong. The company’s five-year sales growth is 3.8%, below the sector median of 7.4%. The company has had positive cash flow from operations in five out of the last five years.

Optex Systems has a Momentum Grade of A, with a score of 87, which is very strong. Optex Systems has a weighted four-quarter relative price strength of 7.2%, significantly above the sector median of –2.1%. During all four of the previous quarters, Optex Systems has had a relative strength above the sector median. The most recent quarter has been the strongest for the company, with a relative strength of 12.5% versus the sector median of –4.8%, ranking it in the 86th percentile of all stocks.

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The stocks meeting the criteria of the approach do not represent a “recommended” or “buy” list. It is important to perform due diligence.

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