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Tickers in this Article: CVU, ATK, FLIR, NOC, LMT, GD, LLL
I'll be the first to admit that a year ago, I figured new President Barack Obama would tip the spending scale back to the butter side of the "guns and butter" spectrum. George W. Bush took us to the extreme opposite end of that line with massive military spending increases. After all, an expensive healthcare overhaul and hundreds of billion of dollars' worth of stimulus would require penny pinching everywhere else, right? Silly me.

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Increased Military Budget Sought
As it turns out, defense contractors may do even better under Obama's spending policies than they did under Bush's. The current president is slated to ask for a military budget of $708 billion for 2011, up from 2010's $680 billion. For comparison, Bush spent $651 billion on the military in 2009. Granted, some of that money will fund the deployment of 30,000 more troops to Afghanistan. Much of that money, however, will have to be spent on equipping those troops, as well as maintaining the war efforts elsewhere with new equipment.

Opportunity Knocks
Political opinions aside, you probably smell the same opportunity I do - aerospace and defense companies have once again been given a reprieve from the recession, thanks to the so-far-infinitely-deep pockets of the U.S. government.

Before you dive into familiar names like Lockheed Martin (NYSE: LMT), General Dynamics (NYSE: GD) and L-3 Communications Holdings (NYSE: LLL) though, let me suggest a set of higher-potential names that you may have never even heard of. While smaller, their nimbleness and lack of current attention from the rest of the market is what makes them such an attractive opportunity.

Bigger Isn't Better
In all fairness to L-3, Lockheed Martin, General Dynamics and Northrop Grumman (NYSE: NOC), the sub-12.0 price-to-earnings ratios for each are impressive. The problem is, with the exception of nice valuations (and unless you need dividends), those big-name defense contractors offer little else that investors generally seek out - like growth and margins.

On the other end of the size scale you'll find slightly higher valuations, but much more of everything else.

Take FLIR Systems (Nasdaq: FLIR) for instance. The imaging/infrared camera manufacturer saw a modest dip in last quarter's earnings, thanks to diminished spending on its BETTS-C surveillance equipment. The demand for that thermal-imaging equipment largely stemmed from the fighting in Iraq, which of course is expected to taper as the U.S. withdraws troops from the area.

Though the company doesn't expect (publicly anyway) demand for night-vision equipment in Afghanistan to be great, bear in mind the conflict there isn't all that different than the one in Iraq, and 30,000 more troops are headed there. Even if the military doesn't need more night-vision equipment, however, FLIR Systems' commercial (non-military) sales were up 34% for the quarter.

Parts Add Up To Profits
Alliant Techsystems
(NYSE: ATK) is another off-the-radar name poised to do well. That's not because it makes any meaningful final product for the military, but because it makes so many other parts used by the major military contractors in addition to being a big supplier of military consumables (e.g. ammunition).

Yes, it's boring on the surface - nobody really gets excited when an Army base receives a shipment of bullets. Investors should care, though. Why? On an operating basis, Alliant Techsystems' income statements didn't suggest a recession ever occurred.

Currently trading at 13 times earnings, ATK would inarguably be a value play. The forward P/E multiple, though, projected at 8.7 for fiscal 2010, is almost implausible. Don't dismiss it, however. Alliant Techsystems has not only been highly profitable over the last four quarters, it has topped EPS estimates in those four quarters by a 7% average.

Subcontracting Is Also Profitable
CPI Aerostructures
(NYSE: CVU) is another obscure name with big military-spending potential. It's a great example of how big defense contractors distribute military dollars to smaller organizations. In December, Lockheed-Martin hired CPI Aerostructures to build plane parts for the U.S. Navy, which was part of a string of business that Lockheed has thrown CPI's way recently.

Either way, trading at an earnings multiple of 12.1 and a forward P/E multiple of 6.3, CPI is another indirect beneficiary of yet another massive military budget.

Bottom Line
There's no need to go on - you get the idea. Even with a modest contraction in 2011's requested military budget, the money's still going to flow - and eventually to the smaller contractors and subcontractors. Those are the defense targets you need to aim for while nobody else is. (For related reading, take a look at War's Influence On Wall Street.)

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