Q&A Time: Opinions on Northrop Grumman and Defense Stocks

Question:

With the possibilities of defense cuts, what are your opinions of Northrop Grumman Corporation (NYSE: NOC) and defense stocks in general?  Also, what sector(s) do you like after the recent market drops?

Answer:

Northrop Grumman is a defense contractor that we own in our Traditional Portfolio. Of course, with the debt ceiling increase, there is a possibility that part of the $1.3 trillion in budget cuts—possibly up to half—could come from defense spending.  It is definitely a dark cloud over defense contractors.

However, we have been here previously. The United States understands the need to maintain a strong military, and Northrop Grumman is one of the premiere contactors. The stock is cheap currently, considering the company has some long-term contracts that are high earners for the company. If you own Northrop Grumman, it should be good to hold. If you do not own it, you may consider buying shares.

If the defense contractors were hit with defense cuts, we feel Northrop Grumman would be one of the companies that would survive by finding alternative revenues. We like the stock as the company has provided good guidance, and the stock is cheap, trading at seven times earnings. It also pays a dividend of 4%.

As far as other sectors, we are overweight in Consumer Staples. Our initial reason was because these companies have an easier time passing along higher prices to consumers. It is a defensive sector that should hold up well in the current environment. Additionally, they are cheap, and generally pay a good dividend. In that sector, we like names, such as, Kimberly-Clark Corp. (NYSE: KMB), Church & Dwight Co., Inc. (NYSE: CHD), The Procter & Gamble Company (NYSE: PG), PepsiCo, Inc.  (NYSE: PEP) and even The Coca-Cola Company (NYSE: KO). Information Technology has also acted as a good defensive play, with names like Apple Inc. (NASDAQ: AAPL) and Oracle Corp. (NASDAQ: ORCL).

We are slightly underweight in Consumer Discretionary as commodity costs have affected them. With the nature of their businesses, they have a tough time controlling costs. They cannot pass along higher prices to consumers, as easily as some other sectors.

Given the recent sell-off, there really is not a lot we would avoid. We consider a universe of 700 stocks, and about 300 of those are trading for a PEG ratio below 1. More than 400 stocks in our universe offer a dividend yield near 3%. We have seen the recent sell-off create some good values in the market.

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