How Buying a “Step-Up” Stock Can Boost Your Defense Profits
Colt Defense LLC filed for Chapter 11 bankruptcy last Monday. Investors were stunned, and questions flew.
How could this happen to America’s legendary gun maker at a time when more than 10 million background checks were completed for gun sales in 2014, including 175,000 on Black Friday alone? Is this a sign that the defense industry is flagging? And, more importantly, what does this mean for my money?
Today I want to talk about that because we’ve got an ideal teaching moment on our hands when it comes to how to invest in what I call the MOST Unstoppable of the six Unstoppable Trends we follow:
War, Terrorism & Ugliness.
Today’s lesson is about how to find a “step-up” stock that positions you for maximum profitability in a sector no one in their right mind actually likes – but no one can afford to ignore, either.
And it applies not just to Colt – which was privately owned – but to public companies like Smith & Wesson Holding Corp. (NasdaqGS:SWHC) and Sturm Ruger & Co. (Stuttgart:ST2.SG), so if you own those or any other firearms maker for that matter, take careful notes.
Here’s the one factor that makes a “step-up” stock…
Why My Least-Favorite Unstoppable Trend Is Here to Stay
There’s no easy way to say this, and admittedly it’s a very discomforting thought, but War, Terrorism & Ugliness are growth industries.
We just saw yet another sad example with the horrifying events at the Charleston, S.C., church this week when an apparently pill-popping, drug-addled 21 year-old named Dylann Roof murdered nine people.
Why this is an Unstoppable Trend is really a moot point. We could spend all day discussing what’s driving this, and it wouldn’t be wasted if the world returned to more peaceful times. But that’s not likely to happen. Not anytime soon, sadly.
According to Amy Belasco, a Congressional Research Specialist, the cost of Iraq, Afghanistan, and other global War on Terror operations since 9/11 tops $1.6 trillion. The figure jumps to $4.4 trillion and counting when you factor in interest rate payments, veteran’s care, homeland security, and other war-related aid, according to a 2014 paper from The Watson Institute for International Studies at Brown University.
At the same time, more people want personal defense, the military needs more firearms, law enforcement has to “up gun” to counter increasingly well-armed criminals, and there’s a lot of legislative momentum against guns which implies a looming scarcity.
Under the circumstances, it’s a logical move to go with gun makers like Smith & Wesson, Sturm Ruger, Olin Corp., and Colt Defense. Yet that’s the wrong move.
What most people are missing is the fact that guns are a dime a dozen. You load, point, and pull the trigger. Then a projectile comes out one end that’s intended to kill.
Functionally speaking, guns are merely more sophisticated versions of slingshots, knives, and bows and arrows that have been used for thousands of years. Soon people will even be able to make a “wiki weapon” using commercially available 3D printing technology.
Again, you may have your opinion about this just as I do mine. Understandably, the issue is fraught with emotion. But the emotion that this subject stirs – or any other emotion, for that matter – has no place in any investing strategy.
What matters from an investment perspective – and what most people are missing – is that a growing number of competitors in a crowded field make firearms an increasingly low-margin business. Anyone can do it. There’s no defensible “moat,” as they say, and that makes it a bad investment.
Let me give you an example that illustrates my point.
No Company Has a Monopoly on Innovation – But Some Collapse without It Anyway
Michael Dell came out of nowhere in 1984 when he began selling hand-built computers from his UT dorm room at a fraction of what established competitors charged. By the 1990s, Dell Computer was the fastest-growing company in history, outpacing both Microsoft and Walmart. By 1999, revenues were $18.2 billion annually.
Now smartphones are doing to Dell what Dell did to his competitors: killing his business. The PC market is dying and expects to ship only 293.1 million units this year, according to IDC. Apple sold nearly 74 million iPhones last quarter alone. By 2019 the entire PC market will be $175 billion, or $8 billion less than Apple’s 2014 revenue of $183 billion.
Colt lost a multi-million dollar bid to the military that completely derailed its business because it doesn’t have the technology nor the margins needed to defend itself in an increasingly commoditized industry.
The same thing will happen to other firearms makers. Perhaps not immediately, but ultimately – unless they can develop something that makes them unique beyond just shooting a projectile.
That’s why you want to step “up” the food chain when it comes to making the most profitable investments in War, Terrorism & Ugliness.
Defense Companies Have to Specialize to Survive
Take Kratos Defense & Security Solutions Inc. (NasdaqGS:KTOS), for example.
I initially recommended it to you on January 9, 2015, and it’s returned 32.08% to date, climbing 16% in the last month alone.
This San Diego-based defense contractor provides extremely sophisticated systems integration and manufacturing for the military and national security platforms. It has very specific (and this is key) non-replicable expertise in satellite communication systems, electronic warfare, missile and cyber defense, among other things.
Practically anybody can make a gun these days. But, very, very few companies can do what Kratos does.
Or, consider Raytheon Co. (NYSE:RTN).
I initially recommended the Massachusetts-based defense giant to Money Map Report readers back in August 2011. Since then, the stock has returned 137.68% versus the S&P 500 which has logged only 68.25% in the same time frame.
Like Kratos, the company’s offerings are highly specialized and include everything from guided missiles to space and airborne systems to integrated intelligence and electronics systems including close in weapons systems, kinetic kill vehicles and directed munitions.
Again, guns are easy to make but Raytheon’s offerings aren’t, which is why they can command a premium.
Both companies (and others like them that I will cover in the future) are still great buys in case you’re wondering.
Wrapping up, I hope you see the logic here because it’s critical to bigger profits and long term investing success in any industry – specialized companies with highly profitable offerings that cannot be commoditized are your best bet.
You’ll know you’ve found one when it’s got a solid competitive advantage capable of protecting the longer-term capital growth we know leads to outsized gains and Total Wealth.
Until next time,