Kratos Defense & Security Solutions Inc. (Nasdaq: KTOS) stock is coming into 2015 hot.
It's up 19% this year, trading close to $6. This is a stark reversal for Kratos stock, which hit some bumps at the end of last year.
You see, this little-known defense company struggled in Q3 2014. An earnings miss sent KTOS plunging when the company's Q3 report came out. It lost 13% on the day.
In the month to follow, it bottomed out at $4.28 a share. That's a 36% fall from where it was trading before earnings came out.
The drop was unwarranted. The earnings miss only came because Kratos' aggressive strategy of vying for cheaper contracts ultimately led to competitor protests.
"Many investors seem to have it out for the stock based on a Q3 earnings miss, I have a different opinion," said Money Morning Chief Investment Strategist Keith Fitz-Gerald. "The miss was due to problems in the contracting process and competitors protesting the fact that Kratos was winning so many contracts. Not problems stemming from Kratos itself."
But investors have started to see Kratos' potential. Since hitting bottom in December, KTOS stock has rebounded almost 40%.
And those competitor bids haven't slowed Kratos down one bit. Already this year, Kratos has announced that it's been awarded eight contracts worth over $100 million.
By comparison, its much larger peers in the defense industry have come nowhere near that contract volume. Of the major defense stocks to buy, Northrop Grumman Corp. (NYSE: NOC) has been awarded three. Raytheon Co. (NYSE: RTN) has secured two. And Lockheed Martin Corp. (NYSE: LMT) has won a single contract.
Granted, the contracts aren't as large.
But that's part of the allure of KTOS stock...
KTOS Stock Proves Bigger Isn't Always Better
Lockheed develops fighter jets and secures multiyear, multibillion-dollar contracts. Raytheon has a lock on some of the most crucial missile systems.
But Kratos is a bit tougher to pigeonhole. Kratos is carving out a niche role in a sector that boasts some of the most well-established legacy names on the market.
Just this year, Kratos has been awarded contracts for monitoring systems, drones, electronics hardware, and training systems - just to name a few. This high volume of low-cost contracts is what helps Kratos stand out as a small-cap among the big players like Lockheed and Raytheon.
You see, winning blockbuster contracts can bring with it its own set of problems.
Like in 2001 when Lockheed 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 turned into a political pariah.
The Department of Defense originally planned to buy 750 planes for $25 billion. Cost overruns and production flaws forced the DoD to change course. They planned to buy fewer planes - 339 - for more money - $62 billion.
Congress ended the program in 2009. Only 187 F-22s 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.
Yes, Lockheed had secured a lucrative contract. But it also drew a lot of criticism from Congress. That's not a good position to be in when Uncle Sam is generally the defense industry's most generous paymaster.
Kratos doesn't have this problem with its bids. Low-cost contracts mean little political controversy.
"That makes them very easy to approve in a budget, especially when compared to the multibillion budget items that come under intense scrutiny," Money Morning's 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."
That's not to say Lockheed is a bad stock. Nor is Raytheon or any of the other legacy companies in the defense and aerospace sector. Defense stocks are "must-have" investments, according to Fitz-Gerald.
But right now, as a small-cap, KTOS stock has the most potential to explode. Many of the big defense companies are trading above $100. KTOS is around $6.
And Fitz-Gerald said by the end of 2015, that will be around $10.
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