The Leading Defense Contractor With a Deep 'Moat'

"They had this toy and they wanted to try it out, so they dropped it..."

That's how Admiral William "Bull" Halsey Jr. described the atomic bombs that leveled two cities in Japan.

The then-commander of the U.S. Third Fleet called the bombing "an unnecessary experiment" and "a mistake to ever drop it."

That's just one man's opinion, though a highly informed one.

No matter the disagreement, war should be the last option... But leaders don't always act rationally.

Almost 75 years later, tensions are on the rise. The U.S. has frosty relations with Russia, China, North Korea, and various parties in the Middle East (most notably Iran).

When military escalation happens – whether it breaks into a shooting war or not – military spending picks up, and the folks who build those weapons make billions. Had you bought the stocks of defense contractors during the Cold War (starting in 1947), you'd have made five times more than if you had invested in the S&P 500.

Whether or not a war breaks out, investors must take steps to prepare for it.

Because whatever may happen, military spending will continue to rise to replenish our weakened military and prepare for the growing number of threats around the world. America's defense spending has increased for four straight years. (The U.S. Department of Defense's budget for fiscal year 2019 is a whopping $686 billion.)

And it should continue to go up from there, with much of this money trickling down to defense contractors.

You see, defense contractors help supply the military with missiles, aircraft, and other necessary equipment. In a world filled with threats, these companies can make great investments.

Today's company is perfectly positioned to benefit from the rising tensions...

Lockheed Martin (NYSE: LMT) has long held the title as the most innovative and impressive defense contractor.

Lockheed pioneered early aircraft back in the 1940s. The company built more than 10,000 P-38 fighter planes to fight World War II. It also developed the U-2 spy plane, launched in 1957 and still operational today.

And Lockheed is responsible for the supersonic SR-71 Blackbird, one of the most marvelous feats of aerospace technology in history.

Even with this success, Lockheed was near bankruptcy by the 1970s.

Defense spending rapidly declined in the anti-war aftermath of Vietnam. Additionally, the company made an unsuccessful push into commercial aircraft that lost millions.

The game-changer that brought Lockheed back – among other successes – was the F-117 Nighthawk stealth fighter.

The flying wedge that could slice through enemy radar was a big gamble... and a monster success. At the start, hiding a massive plane from radar seemed impossible.

But when the F-117 went into operation – still completely secret from our enemies – it provided a tactical advantage like none other.

The feat established Lockheed as one of the top defense contractors for the U.S. military. If there's a project underway and a contract to be awarded, Lockheed Martin is in the room.

Now, Lockheed is leading the next wave of military aircraft.

You see, the military is rolling out its Future Vertical Lift (FVL) program, which will replace attack, medium-lift, and eventually heavy-lift aircraft.

Lockheed's SB>1 Defiant is a strong contender to replace the infamous Black Hawk in the medium-lift category. And a division of Lockheed, Sikorsky, is the leading candidate to replace the Kiowa Warrior in the attack category with its S-97 Raider aircraft.

Lockheed's history speaks for itself. That's why the military turns to it whenever it needs an upgrade.

A company with a competitive advantage is said to have a "moat."

One telltale sign that a company has a moat is a high return on invested capital ("ROIC"). This effectively measures the operating income the business generates relative to the amount of capital invested.

Lockheed's ROIC last year was around 38%. This wasn't a one-off...

The company has averaged an ROIC of nearly 46% over the past decade. Those are phenomenal numbers. By comparison, the average ROIC of companies in the S&P 500 Index is around 9%.

Another part of Lockheed's moat is its more than 12,500 patents, which help the company maintain its technological advantage.

In the last 12 months, Lockheed spent $1.3 billion to build and maintain its equipment and factories – these are called capital expenditures (or "capex").

Even after its investments, Lockheed still has significant free cash flow ("FCF"), the amount left over after all operating expenses and capex.

This allows Lockheed to reward its shareholders. Over the past 12 months, the company has paid out $2.4 billion in dividends, and has raised its payout for 16 straight years.

That's not the only way Lockheed returns capital to shareholders... It has bought back more than $1.5 billion in stock over the same period.

As a result of its strong business, Lockheed shares have been on a tear. The stock has more than doubled over the past five years. And as you can see, it recently hit a fresh all-time high...

Yes, war is a grim business... But as long as conflict exists, the military will continue to rely on innovative defense contractors to maintain our national security interests.

With its major projects, billions of dollars more in smaller contracts, and a soaring defense budget to tap into... Lockheed Martin is simply the top contractor in the business.

Sometimes investing is simple.