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Buying small defense stocks on the cheap

Posted By Dick Sterling
December 16, 2013

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Defense stocks have crushed the market in the past year, with several large-caps gaining more than 50% --- so have all the easy profits been made? Yes on the large-caps, but several smaller companies show promise. But the trick is to identify profitable niches.

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First, warfare has changed and is changing. Tanks, fighter planes and warships are being augmented by silicon and electronic circuitry, to a greater degree than ever. The trend seems to be continuing, and the total price of heavy military equipment is increasingly made up of digital components.

Second, military communications rely on wireless technologies which require increasing bandwidth capacity, specialized security, and greater signal strength/range capability. A number of smaller suppliers are catering to this need.

Third, so-called cyber warfare is a gravy train for nimble suppliers. There are dozens of sub-niches within this space, and Silicon Valley is cashing-in on the bonanza.

This general shift to electronic warfare I am describing has resulted in all kinds of niche opportunities for smaller companies looking to fill the gaps in the Lockheed Martin, Raytheon and Northrop Grumman product lines. Three small companies I'm looking at:

Mercury Systems (MRCY) "digital signal and image processing systems" --- the stock trades around $10 and about $250 million market cap. Insiders buying.

API Technologies (ATNY) "radio frequency and secure communications products" --- trades at just over $3 with a market cap of $180 million.

Kratos Defense (KTOS) "Information Technology services and war fighter solutions" --- about $6.75 and a market cap of $380 million.

All three of these defense stocks are comparatively weak, have gotten hammered during the past three years, and are relatively small. They carry risk. They have revenues, realistic upside, and decent prospects.

As an individual investor, you have a competitive advantage in small stocks.

First, institutions have great difficulty trading small stocks because of their size. Second, institutions often adhere to rules which prevent them from buying small stocks. Third, small stocks are not heavily researched, meaning it’s harder for fund managers to assess and follow them. Fourth (and this is related to the first point), small stocks usually lack liquidity, keeping larger players on the sidelines. Fifth, small stocks are unorthodox --- and so the trend-following fund managers are scared of them.

But now for the real challenge: How do you select the right ones? I’ve designed a tool to help you. I’ve developed it to be a fully-automated, quick, easy-to-understand system for separating the outstanding small stocks from the duds. Buy The Small Stock Formula. I believe you’ll agree --- the ease, speed, and results are exceptional. I consider it one of the most valuable tools an investor can own.

Posted by: Dick Sterling, Editor   contact here


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