Wednesday, May 23, 2007

Aerospace And Defense? Fly Commercial

Investors in aerospace and defense are playing with fairly high stakes these days. Over the last five years, the sector's stocks in the Standard & Poor's 500 have outperformed the broader index by 20 percentage points. In the aggregate, U.S. aerospace stocks now trade at 17 times the projected next-12-month earnings, a premium to the market multiple of 15 times projected earnings.

"You're not going to get the same performance out of the aerospace stocks that you did in 2004, 2005, 2006," warns J.B. Groh, an analyst covering the sector for Great Falls, Mont., brokerage firm D.A. Davidson & Co. "You can still beat the market, but not in the same dramatic fashion."

Groh, 39, doesn't speak from vast experience--he started covering aerospace and defense in 2004. But he's had an admirable track record since. According to research firm StarMine, which tracks analyst performance, over the past 36 months, Groh has bested an industry return of 89% (cumulative) by 50%. In our most recent analyst ranking, conducted in partnership with StarMine, Groh was the No. 1 stock picker in his category.

Underlying that success has been his preference for the commercial rather than the defense side of the sector. When he first chose the companies he would cover several years ago, Groh saw a contrarian play in recommending suppliers of equipment to the airlines.

At the time, both sectors had been hit by the effects of the war in Iraq, a so-so economy and severe acute respiratory syndrome, or SARS. The latter, a viral illness first reported in Asia, was blamed for 774 deaths in 2003 and whipped up fears that aircraft cabins were prone to contagion. In mid-2003, traffic across the Pacific dropped 40%.

"I thought, well, you still have to travel," says Groh.

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