NEW YORK (CNN/Money) - With the prospects of a war against Iraq dimming, at least for the time being, should investors in defense stocks be worried?

The defense sector -- which includes firms like aerospace giants Lockheed Martin, Boeing and Northrop Grumman and electronics companies Raytheon and L-3 Communications -- has been one of the few bright spots in the market this year. The Philadelphia Defense Index, a collection of 17 defense stocks, is up 8 percent year-to-date.

And when the U.S. went to war with Iraq more than eleven years ago, the stocks of many defense companies shot up dramatically. From Jan. 16, 1991 -- the day the U.S. launched its first air attack -- until Iraq's withdrawal from Kuwait on Feb. 28, shares of Lockheed gained 15.5 percent while General Dynamics shot up 19 percent. Northrop Grumman surged 39.5 percent.

So now that Iraq has agreed to let U.N. weapons inspectors back in the country, investors should kiss any hope of more defense sector gains goodbye, right? Not necessarily.

Some portfolio managers say that Iraq doesn't matter that much. For the next few years, defense stocks should continue to be a solid group to own since it has become clear that increased spending on the military is a priority of the Bush administration.

"If we go to war with Iraq that will help the stocks but it doesn't change the long-term story," says Rob Lloyd, manager of the AIM Global Science and Technology fund. "I'm not going to sell them if we don't go to war."

Lloyd says that he began buying defense stocks in early 2000 and increased his stake in early 2001 because, after a round of big mergers (Lockheed bought Martin Marietta and Northrop acquired Grumman for example), the surviving companies were generating steady profits and improved margins.

In addition, he said that it was clear that the Department of Defense needed to increase spending in order to upgrade systems after years of budget cuts during the Clinton administration.

Preparing for battle Seven defense stocks that fund managers like. Company  P/E*  Long-Term EPS Growth Rate  Aeroflex  25.5  27.5%  Alliant Techsystems  21.8  14%  Engineered Support Systems  20.7  16.5%  General Dynamics  15.3  12.2%  L-3 Communications  20.7  20%  Lockheed Martin  22.9  10%  Raytheon  16.5  12%   * Based on earnings estimates for 2003 and prices as of 9/19  Sources:  CNN/Money, FirstCall

Then came the events of Sept. 11, 2001 and a renewed focus on Iraq as a military target. As a result, it became even clearer that products like aircraft, missiles and tanks would be in greater demand.

Lloyd owns Lockheed, L-3, Alliant Techsystems, which makes ammunition and rocket propulsion systems, and Engineered Support Systems, which develops electronic equipment used by ground forces, in his fund.

Unlike Corporate America, the Department of Defense can't afford to hold back on purchasing big-ticket industrial and technological items. As a result, Andrew Pratt, manager of the Montgomery U.S. Focus fund, says that this could be just the beginning of a solid run for defense stocks since he thinks the government will continue to spend more on the military each year until at least 2005.

That gives the sector something lacking throughout most of the market -- some much needed visibility.

"Defense companies have customers that are healthy and have increasing budgets over the next five years. That's pretty rare these days," says Pratt, who owns Raytheon and General Dynamics in his fund.

Companies that build weapons, massive aircraft and ships for the government should continue to benefit from increased spending. They certainly land the biggest contracts from the government. Witness the $3.2 billion deal awarded by the Navy last Friday to General Dynamics and the $1.9 billion contract to Northrop Grumman to build guided-missile destroyers.

But given the changing nature of war, some managers think that investing in companies that develop search and reconnaissance technology is an even better bet.

"We think a lot less will be spent on battleships and a lot more on things like radar and the intelligence of defense. It seems like locating the bad guys is the hard part," says Kevin Landis, chief investment officer of money management firm Firsthand Funds.

To that end, Landis likes Raytheon, which as of July 31 was the top holding in the Firsthand Technology Value and Firsthand Technology Leaders fund. Raytheon, in addition to manufacturing aircraft, makes radar and surveillance systems, as well as the Patriot missile.

The Technology Value fund also owns L-3 Communications, which manufactures secure communications networks and explosive detection devices, and Aeroflex, a small cap company that makes motion control sensors for aircraft as well as thermal imaging devices for rifles and other weapons.

Defense technology companies as well as the more industrial firms have enjoyed a decent run this year, thanks in part to the warmongering. But Pratt says that current valuations -- ranging from multiples in the high teens to the low twenties on next year's earnings estimates -- while not cheap, are fair.

Pratt thinks the best value in the group is offered by General Dynamics, which at 15 times 2003 earnings estimates, trades at a discount to the rest of the sector. Still, he says that if investors are looking to buy more defense stocks it makes sense to do so before a possible war is declared because if history repeats itself, the stocks will probably get a significant boost. And that could cause valuations to become too high.

Lloyd agrees, saying that investors need to be a little more cautious since the stocks have already enjoyed solid gains. Of the defense stocks he owns, he says that Alliant Techsystems and Engineered Support Systems would gain the most from a war in Iraq and that valuations are still reasonable, given their above average growth prospects.