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Defense Stocks Are Heating Up: Here’s the Top 3

tank with missile and anti-aircraft artillery weapon

Despite having plunged more than 10% through September and into October, the iShares U.S. Aerospace & Defense ETF (BATS: ITA) has been bouncing back hard this week.  

It was a fall that forced the stock's RSI to hit the low 20s, indicating highly oversold conditions, so a snapback isn't perhaps all that surprising. But what has surprised investors is the core reason behind the sudden surge: war in the Middle East. 

It doesn't make for glamorous reading, but it remains a fact of life that defense stocks tend to outperform when war breaks out. With no sign of tensions calming for the foreseeable future, this upward trend should continue for much of the coming quarter. With that in mind, here are three of the best to consider adding to your portfolio. 

Northrop Grumman Corporation (NYSE: NOC)

Even though 2023 was shaping up to be a down year, with Northrop's stock down 22% at the end of last week, shares of the Denver headquartered company were only back trading at early 2022 levels. The multi-year uptrend that's delivered gains of 400% over the past decade remains intact, and this week's jump might easily be the start of the next stage. 

Northrop was among the top gainers of the entire industry after the weekend's news, which suggests Wall Street considers it exceptionally well-placed to take advantage. 

The team over at UBS initiated coverage of them with a Buy rating yesterday, which matched the rating from Deutsche Bank two weeks ago. The team added a price target of $502 to the stock, which would have shares undoing almost all of this year's slide. 

Lockheed Martin Corporation (NYSE: LMT)

Arguably the best-known on this list, Lockheed is also the only stock of the three that traded at an all-time high this year. While its shares had sunk over the summer, this week's 10% pop means they're trading only 16% off April's all-time high. 

And the best news? The team at Citi still sees further upside. They commented yesterday that defense stocks were "still attractive" even after this week's jump, with Lockheed one of the top names on Citi's list of Buy-rated defense stocks. 

Of the three stocks here, Lockheed also offers investors the best dividend yield at 2.9%. This dividend was only increased last week in a move considered one of the most bullish signals management can give investors. 

General Dynamics Corporation (NYSE: GD)

Year to date, General Dynamics is by far the strongest performer, with its shares down less than 5% versus -9% for Lockheed and -13% for Northrop. They also command the smallest market cap, which perhaps has enabled them to bounce a bit more than their peers over the past week. Investors getting involved will also benefit from a decent 2.2% dividend yield that's been rock solid when it comes to regular increases for the past 25 years. 

Their next earnings report, due towards the end of the month, will give investors a fresh look at the revenue engine, but expectations will be high considering they smashed estimates back in July. That report helped propel the company's twelve-month trailing revenue to more than $40 billion for the first time. It was also the fourth quarter in a row where General Dynamics' revenue grew, something they hadn't done since the backend of 2019.

MarketBeat's MarketRank Forecast tool has them ranked as a Moderate Buy, with at least 10% upside expected from current levels. A move like that would have General Dynamics shares back at all-time highs, making them one of the most tempting defense stocks to own right now. 

While the current shockwaves coming from the Middle East have been good for these defense stocks, it's important to remember that it will be a while before there's a true knock-on effect on their revenue. That's not to say there isn't an opportunity for gains in the meantime, especially if you see the Israel-Palestine conflict worsening from here. 

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