Wall Street pros reveal their top defense stocks — and the same names keep coming up

The war in Ukraine — now nearing its one-year anniversary — and the shooting down of an alleged Chinese surveillance balloon over the United States have once again brought geopolitical tensions to the fore. Countries across the world, including the U.S., Japan, India and South Korea, are hiking defense spending and revising their security protocols. In Europe, defense spending hit a new record high of 214 billion euros ($229.4 billion) in 2021, and Poland, France, and Germany are among the countries that have announced higher military spending in the years ahead. Stock implications These developments have been a boon for defense stocks. The iShares U.S. Aerospace & Defense ETF (ITA), which tracks the performance of U.S.-listed aerospace and defense stocks, rose 8.8% in 2022 and is up more than 2% this year. But market watchers believe there’s still more upside to come — even as a potential fight over defense spending cuts looms in U.S. Congress. “The export of drones to Russia from its allies is creating a demand for the air missile defenses that our large defense contractors make, the ones that dominate the ITA,” Mark Avallone, president of Potomac Wealth Advisors, told CNBC’s “The Exchange” last month. He said defense stocks are “one way to protect the other parts of the portfolio that are under pressure.” His top picks in the sector include Lockheed Martin , Raytheon Technologies , and Boeing . Kenny Polcari, chief market strategist at SlateStone Wealth, is also a fan of defense. He believes recent geopolitical events have placed the stocks “front and center in people’s minds and portfolios.” Polcari added that he expects the trend of NATO countries making “big deals” with major U.S. defense contractors to continue. “I’m bullish on aerospace and defense stocks, and I think those are names that should be in a longer-term portfolio. Raytheon, Lockheed Martin, General Dynamics , and Northrop Grumman are all names in that space that I like,” he told CNBC’s “Street Signs Asia” on Monday. General Dynamics produces the M1A1 Abrams battle tanks that President Joe Biden announced last month would be delivered to Ukraine to enhance its “capacity to defend its territory and achieve its strategic objectives.” The stock is rated “buy” by 67% of analysts covering it, who give it average upside of 15.7%. Morgan Stanley also believes now’s a good time to buy defense stocks. Analyst Kristine Liwag wrote in a Jan. 19 note that potential cuts to the defense budget are not a “slam dunk” and “overblown” fears of deep cuts are starting to ease. The bank’s top pick in the sector is Northrop Grumman, with a recent pullback in its share price providing “an attractive opportunity to accumulate shares.” The bank has an overweight rating on the stock and its $626 price target implies upside of about 39%. Under-the-radar names While the large U.S. defense contractors provide an easy way for investors to gain exposure to the sector, there are some less obvious ways to play the theme. New York-based Moog is Cowen’s top small- and medium-cap pick for 2023. The company designs and manufactures precision control components and systems for the defense industry. The investment bank described Moog as a “transition story” that will benefit from an “extended defense spending lift.” The stock hit a 52-week high on Monday and is up 9.5% this year. Investors might also want to consider lesser-known names in South Korea’s growing defense sector. The country is the world’s seventh-largest weapons exporter and is a key arms supplier to Ukraine’s neighbor Poland. Both aerospace industrial firm Hanwha Aerospace and Hyundai Rotem, a unit of industrial giant Hyundai Motor , have delivered weaponry to the country. Shares in Hanwha Aerospace soared more than 50% in 2022, and analysts covering the stock give it average upside of 36.9%, according to FactSet data. Hyundai Rotem also delivered a standout performance last year, as its share price climbed 36.5%; analysts think it can still go 34.5% higher. Other South Korean stocks with exposure to the defense sector include Hyundai Heavy Industries and Daewoo Shipbuilding & Marine Engineering. Both firms manufacture naval ships. — CNBC’s Michael Bloom and Carmen Reinicke contributed to reporting