Defence stocks may be a worthwhile area of the market for investors to focus their research.
The head of equity strategy at investment platform Saxo – Peter Garnry — is bullish on the sector.
Geopolitical change
Garnry argues that the war in Ukraine and other tensions in the world have “fundamentally changed” the geopolitical environment.
And now there’s a dynamic leading to the break up and realignment of global supply chains to accommodate what will become a “multipolar world” over time.
Part of that movement is increased investment in national defence all over the world. And European defence companies have been big beneficiaries, so far.
Garnry said that central and western European defence countries’ spending increased to $345bn in 2022. In real terms, that’s on par with spending in 1989, when the world still suffered from cold war tensions.
Crucially, Garnry reckons Europe’s defence budgets are now increasing fast and will likely continue growing over 10% per year for the next five years.
Big-winning European companies so far have been names such as Saab, Rheinmetall, Hensoldt, and Kongsberg Gruppen.
However, there are several London-listed companies with all or part of their businesses in the defence industry. And I reckon many of them are worth investigating now. Especially if Garnry’s theory about a tailwind in the sector proves to be correct.
For example, I’d research stocks such as BAE Systems, Rolls-Royce Holdings, QinetiQ, Babcock International, and Serco. All have part of their operations tied to the fortunes of the defence sector.
Top-down or bottom-up?
However, it’s worth bearing in mind that the defence sector can exhibit cyclical characteristics. And that’s a risk for investors. Things may be booming now, but a downturn may only be a couple of national budget decisions away. Things change. And the fortunes of defence businesses can change as well.
Nevertheless, defence stocks can still be a valuable addition to a diversified portfolio. However, when investing for themes, it’s still important to judge each underlying business on its individual merits. Careful stock selection is always key to successful long-term investing.
Meanwhile, defence isn’t the only theme worth digging into right now. But are themes a bit like ghost footpaths we think we see stretching across a wilderness? Look hard enough, and we can see footpaths everywhere. But often they tend to peter out when we try to follow them.
And investing in themes leans towards a top-down approach to investing. But it can be argued that bottom-up investing is often more rewarding. In other words, start with attractive-looking businesses in any sector. Then appraise them according to their quality, value, and business momentum characteristics, regardless of any theme.
Indeed, investors like Billionaire Warren Buffett have made their fortunes largely investing in businesses when they are out of favour. And not when they are part of the theme of the day.
But having said that, an attractive business in an on-theme sector is probably the best of both worlds!
