Even After Trump's Tariff Turmoil, Defense Stocks Cost Too Much

It's not always fun being right -- especially when you write about defense stocks, and you have to tell people that defense stocks are too expensive to invest in right now.

After reviewing the skyrocketing prices of large defense aerospace and contractors last year, I concluded that defense stocks cost too much. Checking back on valuations after prices had fallen in January, I had to remind investors that defense stocks still cost too much. Sad to say, I was right both times, and many defense stocks are continuing to lose value today.

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But are they finally cheap enough to buy now?

Image source: Getty Images.

Defense stocks still cost too much

The short answer is no. But like so much in life, the longer answer is, "it's complicated."

Since January, since President Donald Trump declared a tariff war, since the stock market crashed in response to those tariffs, and since it largely bounced back after the initial wave of panic, half of the 10 big defense stocks I'm watching today trade at higher price-to-sales valuations. The other half are slightly cheaper, but basically unchanged in valuation. On average, though, and across the industry, the defense sector today is slightly more expensive than it was in January.

In other words, defense stocks still cost too much.

How to value defense stocks

My initial thinking, late last year, was to examine the average valuation of 10 popular defense stocks over a 10-year period running from 2004 to 2013, over the 10 years from 2014 to 2023, and also over the entire 20-year period. Data from S&P Global Market Intelligence, which keeps track of such things automatically, made it easy to get all these numbers -- with one caveat.

S&P tracks enterprise-value-to-sales (EV/S) ratios, which are basically the same thing as price-to-sales ratios, with the tweak that, instead of dividing sales into a company's market cap, it divides them into market cap adjusted by net cash or debt. With that in mind, here's how the data look over the periods I examined:

Data source: S&P Global Market Intelligence. * Huntington Ingalls data begins in 2011, the year when Northrop Grumman spun off Huntington Ingalls as a separate company. ** Leidos data begins in 2006, the year of its IPO. Data on its average enterprise value-to-sales ratio for 2014 is missing because the company changed its fiscal year in 2015, skewing the data somewhat.

Compare these numbers to the stocks' current EV/S ratio. And to make it easier for readers to quality-check my numbers, I also provided the P/S ratios. Here's how this all looks today.

Data source: Yahoo! Finance.

One defense stock to buy (maybe)

So what do these numbers prove?

By and large, they indicate that defense stocks still cost too much. For the group as a whole, both P/S and EV/S ratios remain elevated over historical norms. With trade and military tensions growing from Eastern Europe to the South China Sea, that's perhaps not surprising, but it's still not great news for investors wanting to buy into the sector.

If you're dead set on buying a defense stock, though, I do see one potential value option that looks intriguing. Leidos Holdings at a 1.4x EV/S (and a 1.2x P/S) trades within a few percentage points of what investors have historically considered its fair value. It's also a well-diversified company doing business not just in defense, but in national security, healthcare, and civil aviation as well. Given the troubles we've seen this year with civil aviation systems, and air traffic control for example, that could be a growth driver for Leidos, over and above the broader trend of increased defense spending.

Leidos stock, at least, bears watching. The others are probably better to watch... and wait on.

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Rich Smith has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends L3Harris Technologies. The Motley Fool recommends Lockheed Martin, RTX, and Textron. The Motley Fool has a disclosure policy.