Investor Essentials Daily

This defense contractor will keep rising with the military budget

February 13, 2024

The increasing global conflicts have necessitated higher military budgets, with global military expenditure hitting $2.3 trillion in 2022, a 3.7% increase from the previous year.

This rise in military spending is driven by the need to address geopolitical tensions and conflicts such as Russia’s war in Ukraine and tensions with China. This emphasizes the importance of military readiness and modernization.

V2X (VVX), a defense contractor formed by the merger of Vectrus and Vertex in 2022, stands to benefit from this trend, offering logistics, cybersecurity, AI/ML solutions, and training, aligning with the U.S. military’s priority investment areas.

Despite V2X’s strategic positioning, market reception has been pessimistic.

Thus, VVX showed up on our screen. The company makes a great FA Alpha 50 name due to its potential for high returns and low expectations from the market.

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The increasing prevalence of global conflicts has created a pressing need for higher military budgets worldwide.

According to data from the Stockholm International Peace Research Institute (SIPRI), total global military expenditure reached $2.3 trillion in 2022, representing a 3.7% increase from 2021 in real terms.

In the United States, one of the largest military spenders globally, the budget of the Department of Defense (DoD) has also seen consistent growth.

For its 2021 fiscal year, the DoD budget was approximately $700 billion. By 2023, that budget had grown significantly to eclipse $815 billion according to the National Defense Authorization Act passed by Congress.

The rising costs of addressing ongoing conflicts around the world are a major driver of higher military budgets.

From Russia’s war in Ukraine to tensions with China in the Indo-Pacific region, geopolitical flashpoints are intensifying the need for military readiness and modernization.

Defense contractors positioned to support priority investment areas stand to benefit from this trend of growing defense budgets.

One such company is V2X (VVX), a global government services firm.

Formed in 2022 through the merger of Vectrus and Vertex, V2X brings almost 80 combined years of experience supporting defense and government customers globally.

V2X delivers services, software solutions, and training across air, land, sea, space, and cyber domains.

V2X’s focus on providing services, software, and training to military customers positions it well to gain from areas prioritized in defense budgets like logistics, cyber, and personnel support.

Specifically, V2X provides logistics, maintenance, and infrastructure support for U.S. bases overseas. It also offers cybersecurity, AI/ML, and engineering solutions – core competencies directly aligned with DoD modernization initiatives. Through its recruitment and training programs, V2X further aids priority personnel readiness efforts.

Given its strengths in logistics, technology, and training, V2X appears well-suited to capitalize on defense budget allocations.

Its presence in over 20 countries, including a major Middle East footprint, also positions the company as a strategic partner amid evolving threats.

We can already see these factors in play.

In the last year, V2X’s Uniform return on assets (ROA) reached above 53%.

Take a look…

V2X’s core competencies in services, software, and training align seamlessly with the U.S. military’s priority investment areas, reflecting a strategic alignment with the evolving needs of modern warfare and defense strategy.

Despite V2X’s strategic positioning and alignment with priority investment areas of the U.S. military, the market’s reception has been pessimistic.

We can see this through our Embedded Expectations Analysis (“EEA”) framework.

The EEA starts by looking at a company’s current stock price. From there, we can calculate what the market expects from the company’s future cash flows. We then compare that with our own cash-flow projections.

In short, it tells us how well a company has to perform in the future to be worth what the market is paying for it today.

At the current stock price, the market predicts that the company’s Uniform ROA will fall to 28%.

The market’s pessimistic view is caused by the dependency on fluctuating government defense budgets and contracts, which can be impacted by changes in political priorities and economic conditions.

With its considerable presence in the Middle East, V2X is not merely a beneficiary of increased U.S. military spending; it is a critical enabler of American strategic interests in a region that remains a focal point of global tensions.

The merger brings together complementary strengths, with Vertex’s technological and logistical capabilities merging with Vectrus’ regional expertise and operational experience.

This synergy positions V2X as a formidable player in the defense contracting arena, equipped to offer sophisticated solutions that address the multifaceted challenges of contemporary military operations.

Throughout financial market history, many of the world’s most successful investors have been candid in their belief that Generally Accepted Accounting Principles (“GAAP”) distort economic reality.

Warren Buffett, for example, once said investors should “concentrate on the world of companies, not arcane accounting mathematics.”

Investors who neglect the very real issues with as-reported accounting can find themselves caught up in investing with the crowd, blindly following hot “themes” without a thorough grasp of how to understand the businesses in question.

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That’s exactly what we’ve set out to do with the FA Alpha, our monthly list of 50 companies that rank at the top for quality, high growth, and low valuations.

This list has outperformed the market by 300 basis points per year for over 20 years now, effectively doubling the performance of the market by focusing on the real fundamentals and valuations of companies with our proprietary Uniform Accounting framework.

See for yourself below.

To see the other 49 names on the list, click here.

Best regards,

Joel Litman & Rob Spivey

Chief Investment Strategist &
Director of Research
at Valens Research

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