Right now, somewhere in the skies over Iraq, Afghanistan or someplace else in that troubled region, lurks an all-seeing bird of prey, silently scanning the terrain below in search of a target.

If you thought this narrative was about one of the many breeds of falcon that make this region home, you'd be wrong. For the "eyes" of this particular bird of prey consist of an advanced digital imaging system, and in its "talons" are a clutch of Hellfire missiles.

I'm referring to the Predator; the most advanced reconnaissance and attack unmanned aircraft currently deployed by any military anywhere.

Robot Warriors on the 21st Century Battlefield
While matters of national security limit what we know of the Predator's service record, the occasional media report suggests that its performance has exceeded expectations.

That's probably why the U.S. military is now investigating the development and deployment of other Unmanned Aircraft Systems (UAS) onto the 21st century battlefield.

Relative to other more established defense programs, new and existing UAS initiatives are still in their infancy and only involve a fraction of the dollars committed to developing more traditional systems. However, the UAS market is expected to grow at a rate significantly ahead of the overall defense budget over the next few years.

Major Defense Contractors have Little Exposure
In light of this, are there any opportunities for investors in this emerging defense industry trend?

Unfortunately, in the case of a highly advanced system like the Predator, there is no direct pure-play investment available. The aircraft is currently manufactured by a private defense contractor, General Atomics, which has never been nor is ever likely to go public.

But there are a number of public companies that provide key components to the Predator. Both L-3 Communications (NYSE: LLL) and Raytheon (NYSE: RTN) provide radar, cameras and various sensors, and Honeywell (NYSE: HON) will be supplying the turboprop engine to a more advanced and lethal variant of the Predator known as "The Reaper".

The Navy is now in the final stages of selecting a contractor to build its own unmanned aircraft which will reportedly incorporate stealth technology, be capable of landing on an aircraft carrier and have an operational range of 3000 nautical miles. Boeing (NYSE: BA) is currently competing against a joint Northrup Grumman (NYSE: NOC) and Lockheed Martin (NYSE: LMT) team to win a $1 billion contract to build the prototype. (To learn more about investing in defense contractors and other "sinful" companies, read A Prelude to Sinful Investing.)

While all this looks promising for the companies participating in these programs, the sums involved are so small relative to their total revenues that there's virtually no meaningful exposure to the UAS market through share ownership in any of them.

One Company has a Niche
So, if big doesn't work, perhaps small will. While it may not make anything nearly as advanced as the Predator, AeroVironment (Nasdaq: AVAV) does have a small and potentially high-growth piece of the $1.6 billion UAS market. The company makes small, tactical aircraft, roughly the size of a large model airplane, that provide real-time video surveillance for ranges over six miles. It's a cutting-edge way for a commander on the ground to get an over-the-hill view of where the enemy might be.

While the primary customer for AVAV's products is still the Department of Defense, which involves standard military contracts with limited profit margins, there are a wide range of civilian applications that have yet to be fully penetrated for these small and inexpensive reconnaissance aircraft This includes forest-fire watch, border protection, monitoring of pipeline or utility assets and numerous applications in law enforcement.

Of the $170 million in total revenue the company expects to realize this fiscal year, about 85% comes from these small UAS aircraft. Sales have been strong of late, up over 35% in the latest quarter. Overall revenue growth should easily exceed 25% per year over the next couple of years.

With strong growth prospects like this, don't expect a discount on the stock's valuation. It now trades at a fairly hefty forward P/E of 25-times 2008's expected EPS of 89 cents. But, I think its worth paying up the premium to own a piece of the only pure play in this emerging new market.

Looking to cook up a market-stomping stock portfolio? Check out our FREE report "7 Ingredients to Market Beating Stocks" and get started right now!

Related Articles
  1. Mutual Funds & ETFs

    What Exactly Are Arbitrage Mutual Funds?

    Learn about arbitrage funds and how this type of investment generates profits by taking advantage of price differentials between the cash and futures markets.
  2. Investing News

    Ferrari’s IPO: Ready to Roll or Poor Timing?

    Will Ferrari's shares move fast off the line only to sputter later?
  3. Stock Analysis

    5 Cheap Dividend Stocks for a Bear Market

    Here are five stocks that pay safe dividends and should be at least somewhat resilient to a bear market.
  4. Investing

    How to Win More by Losing Less in Today’s Markets

    The further you fall, the harder it is to climb back up. It’s a universal truth that is painfully apparent in the investing world.
  5. Fundamental Analysis

    Use Options Data To Predict Stock Market Direction

    Options market trading data can provide important insights about the direction of stocks and the overall market. Here’s how to track it.
  6. Stock Analysis

    2 Oil Stocks to Buy Right Now (PSX,TSO)

    Can these two oil stocks buck the trend?
  7. Investing News

    What Alcoa’s (AA) Breakup Means for Investors

    Alcoa plans to split into two companies. Is this a bullish catalyst for investors?
  8. Stock Analysis

    Top 3 Stocks for the Coming Holiday Season

    If you want to buck the bear market trend by going long on consumer stocks, these three might be your best bets.
  9. Investing News

    Could a Rate Hike Send Stocks Higher?

    A rate hike would certainly alter the investment scene, but would it be for the better or worse?
  10. Investing News

    Corporate Bonds or Stocks: Which is Better Now?

    With market volatility high, you may think it is time to run for corporate bonds instead of stocks. Before you do take a deeper look into which is better.
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!