President Trump Might Ban Defense Contractor Dividends. What Does That Mean for Investors?

No doubt about it -- President Donald Trump spooked a lot of investors in defense stocks earlier this month.

Writing on Truth Social about "exorbitant and unjustifiable" executive compensation in the defense industry, "massive Dividends," and "massive Stock Buybacks," all paid "at the expense and detriment of investing in Plants and Equipment," the president declared that "no Executive should be allowed to make in excess of $5 Million Dollars." Furthermore, he promised to "not permit Dividends or Stock Buybacks for Defense Companies" until a long list of alleged defense contractor wrongs were righted.

"NEW and MODERN Production Plants" must be built, "both for delivering and maintaining" military hardware. And the speed of "maintenance and repair of Equipment, once sold ... must be immediately enhanced."

Image source: Getty Images.

Essentially, the president offered a stick to go along with the carrot of proposing that Congress increase the defense budget to $1.5 trillion. The extra money contractors will receive (assuming Congress approves the increase) must be invested in improving their businesses -- not passed along to executives in the form of fatter paychecks, nor to shareholders as dividends and stock buybacks.

And just in case you weren't sure if he was serious, the president proceeded to sign an executive order to this effect.

What the order says

On Jan. 7, the same date as the Truth Social post, the White House issued a "fact sheet" describing the executive order on defense dividends and share buybacks. It clearly laid out the rationale of the order in either/or fashion, ordering defense contractors "to stop ... putting stock buybacks and excessive corporate distributions ahead of production capacity, innovation, and on-time delivery for America's military."

But here's the critical point for investors: It doesn't do that yet.

According to the order, Defense Secretary Pete Hegseth is first directed to "identify" defense contractors that "underperform, fail to invest their own capital in production capacity, insufficiently prioritize U.S. government contracts, or maintain inadequate production speed."

Such contractors will then be notified of where they are falling short and given an opportunity to "resolve the issues" identified before any action is taken against them. They will have 15 days to submit a plan of action for resolving the issues.

Failure to submit the plan of action, a judgment by the Defense Secretary that the plan is insufficient, or later failure to resolve the issues will empower the Hegseth to "immediately" enforce or renegotiate the contract in question, and potentially invoke the Defense Production Act. (The DPA empowers the president to direct companies to take actions outside of normal market mechanisms, such as producing products in greater quantities or on faster timelines than they ordinarily would, to help the government deal with national emergencies.)

All the above relate to defense contractors' performance on existing contracts. As regards future defense contracts, the secretary is instructed to build this requirement into the contract language: Failure to prioritize government work, failure to meet deadlines, failure to invest sufficiently in the business -- any of these will trigger a ban on paying dividends or buying back stock, and permit the secretary to impose a salary cap on a company's executives.

Other, additional remedies are discussed in the executive order, but these are the big ones.

Are dividends and stock buybacks banned?

To the best of my knowledge, as of Jan. 17, 10 days after the executive order was published, no specific defense contractors have been cited by name yet -- or at least, none have been named publicly.

In my periodic review of defense contractor stock valuations, I track 10 of the nation's largest defense contractors. These defense stocks seem the most likely targets of the president's ire.

Here's how their dividend yields and buybacks stack up today:

Data sources: Finviz.com, Tipranks.com; *Buyback data either not available or negligible in amount. YTD = year to date.

Across the 10 companies, the average dividend yield for defense stocks is only 1%, which may not sound like much. Still, the average dividend yield on the S&P 500 today isn't much higher -- barely 1.2%. Furthermore, more than half the defense companies on the list pay more than that, with Lockheed Martin, General Dynamics, and L3Harris among the most at risk.

Adding to the concern, Lockheed Martin and L3Harris are the two largest buyers of their own stock -- a second target on each of those companies' backs. If Trump decides to make an example of any defense stock to show he's serious about wanting to ban defense stock dividends, those are the two most likely to suffer.

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