This Little-Known Defense Stock Is a Hidden Gem

defense stocksDefense stocks are among today's "need-to-have" investments.

Threats to U.S. safety are growing. Combat operations have wound down in Iraq and Afghanistan, but even as the last soldiers came home, extremism has had a violent rebirth in the Middle East.

The current battle with the Islamic State of Iraq and Syria (ISIS) is far from over. This is especially true regarding the U.S.'s cautious air campaign that has fallen far short of "degrading" (much less "destroying") ISIS, as U.S. President Barack Obama pledged to do.

And with U.S. Secretary of Defense Chuck Hagel stepping down today (Monday), the future of U.S. defense is uncertain.

Now more than ever, defense stocks are a good buy because defense companies provide certainty. They will help shape future U.S. combat roles regardless of what those become. They will deliver the appropriate technology to conduct 21st century warfare.

Money Morning Chief Investment Strategist Keith Fitz-Gerald describes this as "standoff warfare."

"What this means in plain English is that our military is transitioning to hyper-accurate weapons that can target enemies from miles away, keeping our service members out of harm's way until they absolutely have to personally engage," Fitz-Gerald said. "That way, they can limit resources and exposure while still achieving maximum effectiveness on target."

Almost all defense stocks will be good buys. One way to profit is to go for the big guys.

Raytheon Co. (NYSE: RTN), Lockheed Martin Corp. (NYSE: LMT), Northrop Grumman Corp. (NYSE: NOC), and even Boeing Co. (NYSE: BA) are among the top picks.

But each one of those stocks is selling at above $100.

That's why we found this ultra-cheap stock that is making a name for itself in defense, specializing in services that the industry giants don't.

The Hidden Gem in the Defense Sector

That stock is Kratos Defense & Security Solutions Inc. (Nasdaq: KTOS).

Kratos is a specialized defense firm based in San Diego, Calif. It tailors to what the military community calls C5ISR (command, control, communications, computers, combat systems, intelligence, surveillance, and reconnaissance). The company has a broad portfolio of products and services: creating components for radar systems, manufacturing and testing surveillance drones, providing cybersecurity services to government agencies, and more.

In fact, just last week, the U.S. Navy deployed the U.S.S. Ponce and fitted it with the first-ever laser weapon system - a system developed by Kratos.

The company has a diversified contract base. While it is reliant on the Department of Defense for much of its business, 35% of it lies outside of this agency, and no single contract accounts for more than 6% of revenues.

The market doesn't love KTOS right now. While companies like General Dynamics Corp. (NYSE: GD) are up over 50% on the year, KTOS stock has fallen about 35%, trading at $5.05 at Friday's close.

But at this point, it's undeservedly unloved.

Kratos doesn't have the history and name recognition of the big brands - and that can be a good thing.

Kratos wasn't developing fighter jets in World War I, or missile systems in World War II like the established defense companies today with nearly a century of history.

But while established names like Lockheed Martin are a great buy, the company's sheer size has been a handicap.

For example, in 2001, Lockheed Martin secured a contract to create the most expensive combat aircraft in U.S. history: the F-22 Raptor. This was a stealth joint-strike fighter that would cost $350 million per plane.

Unfortunately, the F-22 program was, by many measures, a disaster.

In the original plan, the DoD would buy 750 planes for $25 billion. But cost overruns and production flaws forced the DoD to change course, instead altering the plan to fewer planes (339) for more money ($62 billion).

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The end results were much worse. When all was said and done and Congress ended the program in 2009, only 187 were delivered, at a cost of $66.7 billion.

On July 21, 2009, when the Senate voted 58-40 to kill the F-22 program, LMT stock fell 8.5% on the day, its 22nd worst performing day in company history.

Lockheed Martin has had to take a lot of criticism for the program from big names among the military community, like Sen. John McCain (R-AZ), and it's episodes like this that can knock the legacy defense contractors out of favor.

That's where the benefits of investing in KTOS come in.

KTOS Stock Resists Washington Shenanigans

You won't see Kratos vying for contracts of more than $15 million, making budget approval for these items a lot more feasible in the extremely political game of defense procurement.

"That makes them very easy to approve in a budget, especially when compared to the multi-billion budget items that come under intense scrutiny," Fitz-Gerald said. "They're almost all high-tech or in support of high-tech mission profiles, which means they represent a critical need rather than a pork program that politicians want to keep alive so they can get re-elected."

By carving out a niche role in the sector, Kratos has been able to dominate markets the big boys haven't.

For example, the company's EPOCH Command and Control System is used by more than 75% of commercial satellite operators and federal defense agencies. And at the same time, it does this away from the yoke of political bickering that has hamstrung contractors handling large contracts like Lockheed Martin.

The Bottom Line: Don't get us wrong, LMT is a great stock, and defense is a "need-to-have." But for a solid stock that won't be subject to political whims - a common criticism of buying defense stocks - KTOS is a good way to go, and at a discount.


Next on Defense Stocks: The United States is not embroiled in extensive military campaigns overseas - at least not like it was a decade ago. Some will make the mistake of assuming the United States' shrinking military presence makes it a bad time to buy defense stocks. But many defense stocks have value that far transcends their necessity on the battlefield...