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Playing Defense for Growth & Dividends

March 28, 2019

One of my core mechanisms for finding the best stocks for growth and dividends is to look at economic, market and social or political developments that will spur more demand for specific goods and services.

I do this by consuming a great deal of news, subscribing to many industry and professional journals and staying glued to my Bloomberg terminal, with all of its analytical and data tools.

When I find developments that tick all the boxes for more demand in a sector, I then drill down to find the most promising companies that will profit most from that new demand.

I determine which will be sales growth leaders. I look for the ones with the best and improving margins—a key marker for rising earnings growth and usually higher stock price potential.

After all this, I explore downside risks, and I run “what-if” scenarios to see how they will likely cope if things don’t go their way.

Finally, I put my banker hat on and look at the debts of the companies and determine if I would lend money to this company. If not, I have no business recommending it as a buy for you.

One of the big developments underway now is in defense spending. Defense and military spending are set to hit a post-Cold War high of $1.84 trillion, up almost 18% since 2008, according to Jane’s Defense Budgets.

This will be the fifth consecutive year of increased spending and will top last year’s record spending of “only” $1.78 trillion. And with European and other North Atlantic Treaty Organization (NATO) countries upping their pledged spending after being prodded by President Trump, along with increased Chinese and Russian budgetary spending, military spending is one very important global trend.

The US dominates military spending—its budget represents nearly 40% of overall global military spending. And that’s before counting overseas war spending that is separate from the general Pentagon budget.

The current arms race is a global phenomenon right now, with big players like Russia, China and India ramping up spending, as well as countries in the Middle East, the Pacific Rim and Europe also boosting budgets.

In Profitable Investing, I already have a company that will continue to profit from this spending boom—Total Return Portfolio resident United Technologies (UTX).

While UTX has more benign products and services such as its elevator (Otis) and building services, including fire suppression as well as heating and cooling products (Carrier), it also produces crucial defense products for aviation.

The company’s Pratt & Whitney division makes engines for aircraft as well as plenty of other parts and services for military as well as civilian aircraft and drones. And with its acquisition of Rockwell Collins—its new aerospace division is now called Collins Aerospace—it provides an additional arsenal of aircraft equipment and services.

UTX’s revenue growth should continue as the U.S. and global military spending spree intensifies. And operating margins (a good barometer of profits) remain solidly in the double-digits, helping UTX deliver strong stock performance year after year.

It also pays a solid dividend of 2.33% and has been increasing its distributions by an average of 4.99% per year over the past five years.

The shares have performed well over the past decade, with an average return of 13.65% per year.

United Technologies (UTX) Total Return—Source: Bloomberg Finance, L.P.

In addition, there’s an additional boost in store for UTX shareholders. Over the next two years, the company will be splitting up its divisions. The aerospace and defense unit will go its own way, and its Otis and Carrier divisions will also become separate entities.

This will unlock a tremendous amount of value.

Otis and Carrier could be sold for cash to private equity or other entities or could be spun off as separate shares. The conglomerate is cheap at just 2.83 times its book value, which is dramatically less than other aviation and military companies. And at a price to trailing sales ratio of 1.5, it’s an even better bargain.

Bottom line: United Technologies is a great long-term total return buy.