By Al Root
Can defense stocks deliver both dividends and capital-spending-driven growth? Income investors are about to find out.
On Jan. 7, President Donald Trump signed an executive order that threatened defense companies' ability to allocate capital on their own if they didn't deliver innovative defense technologies on time and on budget. "Many large contractors -- while underperforming on existing contracts -- pursue newer, more lucrative contracts, stock buybacks, and excessive dividends to shareholders at the cost of production capacity, innovation, and on-time delivery," read part of the order.
A little bit of math shows why investors are right to be concerned about the executive order being enforced. Large U.S. defense contractors -- excluding Boeing, which doesn't pay a dividend or buy back stock -- yield about 1.4%, while paying out some $12 billion in dividends over the past 12 months and buying back $15 billion in stock. The combined $27 billion consumed nearly 90% of net income and was roughly $3 billion more than spending on new plants, equipment, and research.
There's a good chance, however, that Trump's executive order isn't meant to be enforced, but rather to serve as a warning to defense contractors. It could even make the stocks more attractive in the future if it's taken as a signal that they need to invest for more growth, pronto. "You can negotiate, you can cut a deal, and you can get yourself off the no-fly list," says RBC analyst Ken Herbert.
On fourth-quarter earnings calls, management teams showed no sign of imminent dividend cuts. "Yes, 100%," was Northrop Grumman Chief Financial Officer Ken Crews' response to a question about continuing to pay dividends. He wasn't the only one. "We recognize our shareholders rely on our dividends, and they've come to expect our dividends," added RTX CEO Christopher Calio on his company's call. "So we remain committed to the dividend."
But defense companies have also committed to raising capital spending to expand and streamline manufacturing capacity across many programs. Spending in 2026 is projected to rise 30%. More investment consumes cash, but ideally leads to more growth. New contracting priorities at the Defense Department create stable growth opportunities for companies, said Lockheed Martin CEO Jim Taiclet on Thursday, adding that expected returns from any new investment will exceed Lockheed's cost of capital. Lockheed has already announced plans to expand its PAC-3 Patriot missile system and Thaad high-altitude missile interceptor program.
That's a sign that defense companies are taking Trump's message to heart. "Like its peers, Lockheed basically has no choice but to invest if it is to participate in the growth trajectory that should be ahead," says Vertical Research Partners analyst Rob Stallard. "While the situation remains fluid, this corporate cooperation on capex could ease the government's ire about defense company share buybacks and executive pay."
Growth could also get a boost from rising geopolitical tensions, higher military spending in the U.S. and Europe, the proliferation of new autonomous technology, and the emergence of space as an opportunity and threat. Those are all counterbalances to potential capital controls.
Trump's executive order could even turn out to be a boon if the dividends are safe and growth is up. Wall Street's favorite defense contractors are GE Aerospace and L3Harris Technologies, which boast Buy ratings from more than 70% of analysts covering them and dividend yields north of 1%. Alternatively, investors can just buy the sector, given that most defense stocks have been strong performers lately. Coming into Friday trading, the iShares U.S. Aerospace & Defense exchange-traded fund was up 52% over the past 12 months, about 37 percentage points ahead of the S&P 500. The ETF, however, yields only about 0.5%.
No matter the choice, remember that there's a lot going on in defense -- most of it positive for the stocks.
Write to Al Root at allen.root@dowjones.com
This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.
(END) Dow Jones Newswires
January 30, 2026 01:30 ET (06:30 GMT)
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