Does troop surge mean a defense-stock surge?Stepping up the Iraq war may be good for the sector, but some companies have already profited. Fortune's Jon Birger guides investors through the defense minefield. NEW YORK (Fortune) -- Will the planned troop surge in Iraq lead to a stock surge for defense contractors? The short answer is: probably not. Yes, defense companies specializing in equipping the troops on the ground will likely get a boost in orders as a result of President Bush's plan to send another 20,000 troops into Iraq. Some likely beneficiaries: armor and body armor makers like Ceradyne (Charts) and Armor Holdings (Charts), battlefield computer and communications equipment company DRS Technologies (Charts), and armored-vehicle maker Force Protection (Charts). Among the major defense defense contractors, the best bet is General Dynamics (Charts), maker of the Abrams tank and other military vehicles.  The problem is that expectations of a surge are already built into their stock prices. Armor and DHS are up 20% since November, for example. Force Protection is up 100%. The easy money has already been made. That being said, there's still a secular case to be made for defense as a sector, one that goes beyond the narrow benefits of 20,000 more troops in Iraq. As much money as the U.S. is spending on defense, the untold defense-sector story is the arms race unfolding abroad. Fueled by high commodities prices and rising political unrest, spending on armaments is on the rise all across the globe. And U.S. defense contractors have an edge over their European rivals, says retired Air Force brigadier general David Baker, now an analyst with Stanford Washington Research Group, because their products "have been proven in combat." In recent months the Department of Defense has announced the sale of $1.5 billion in fighter jet engines to Saudi Arabia, $123 million in F-16 parts to Chile, and $300 million in military helicopters to Brazil, for example. Other big orders for U.S. arms have come from Japan, Jordan, Greece, and South Korea not to mention Iraq itself. The bottom line: what's happening in Iraq is simply the most visible manifestation of an increasingly militarized world, a point Merrill Lynch (Charts) chief investment strategist Richard Bernstein made in a recent report. And while that may not bode well for world peace, it is good for the bottom lines of defense companies. The simplest way to play this trend is with an exchange traded sector fund: PowerShares Aerospace & Defense Portfolio (Charts). As for individual stocks, our favorite defense name is the same one FORTUNE picked in our 2007 Investor's Guide: General Dynamics. In addition to its core defense businesses, General Dynamics also owns red-hot corporate jet maker Gulfstream, itself a backdoor homeland security play. With more and more corporations seeking to shield executives and other key personnel from the delays and hassles of flying commercial, Gulfstream boasts an order backlog of $6.5 billion, up from $5.2 billion a year ago. --------------------------------------------------- |
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