Got $5,000? 1 Defense Contractor Set to Be a Long‑Term Compounder.

Sometimes markets throw investors curveballs, and the war in Iran is a prime example. Many market participants expected armed conflicts to be catalysts for defense stocks. It's a reasonable expectation to be sure, but the market isn't known for making things easy.

The war in Iran has dragged on longer than expected, and speaking of drags, that's exactly what the broader aerospace and defense segment is dealing with now. For the three months ended April 28, the iShares Aerospace and Defense ETF (NYSEMKT: ITA), one of the bellwether exchange-traded funds (ETFs) addressing the industry, is off almost 9%.

This defense contractor is offering some value and real compounding potential. Image source: Getty Images.

Down nearly 15% over the same period, Northrop Grumman (NYSE: NOC) is an even more egregious offender. If the stock hadn't eked out a gain on Tuesday, April 28, that would've marked its 11th consecutive losing day, good (well, maybe bad) for its worst skid in nearly 16 years. Think about that. A major defense contractor on a 10-day losing streak amid a hot war. That doesn't sound like a recipe for long-term compounding, but a deeper examination of this industrial stock reveals otherwise.

Northrop's earnings growth is taking flight

In standard value stock talk, Northrop is arguably neither too hot (so deeply undervalued it rings alarm bells) nor too cold (excessively overvalued). It trades at 20 times earnings, up slightly from 18 a year ago. There's good news for investors looking for a credible compounder: The earnings growth may well be there to sustain a higher multiple.

Over the past three years, the B-21 maker grew earnings at a steady, though unremarkable, 1% rate. That's expected to accelerate to 8% over the next three years. Identifying this company's growth opportunity set is easy, as it largely boils down to three pillars: the Sentinel weapon system, the possibility of refreshing the B-21 fleet by 100 new aircraft, and increased militarization of space.

With the SpaceX initial public offering (IPO) imminent, it sure feels like every stock with even the faintest inroads to the final frontier is hot. To be sure, Northrop isn't a space stock in the purest sense of the term, but its space resume is legit.

The company is already a leader in rocket propulsion systems of the "mission critical" variety, and it's making clear it wants to be a prominent player on the disruptive technology stage, which could include space. That commitment includes building 11 new facilities and modifying 16 others to accommodate rocket-related programs. Moves like that are exactly what the federal government likes to see when it comes time to award the contracts that are the lifeblood of the defense industry.

Looking for compounding? Look at the cash.

Every compounder is different, but they often share similarities, including strong balance sheets that strengthen over time and impressive cash-flow-generating capabilities. Northrop Grumman is only slightly more levered than its peer group, but it is a strong free-cash-flow producer. The aerospace and defense company forecasts free cash flow of $3.1 billion to $3.5 billion in 2026.

Another point about compounding and free cash flow: Northrop's free cash flow is expected to double by 2028, and that's a big deal to investors because the company often returns that capital to shareholders through buybacks and dividends.

Speaking of dividends, Northrop has increased its payout for 22 consecutive years, with the last hike in May 2025, potentially signaling another hike is right around the corner. With the company sitting on a substantial order backlog and a bright free-cash-flow outlook, the dividend could be a component of this stock's longer-range compounding picture.

Todd Shriber has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.