With skyrocketing debt, cost cutting seems to be the new trend of policy makers within Washington. To that end, military and defense spending is directly in the cross-hairs. The deficit-cutting super-committee's recent failure to decide where to cut at least $1.2 trillion in savings, will produce automatic and across-the-board cuts for defense programs beginning next January.

Meanwhile, President Obama and Defense Secretary Leon Panetta recently outlined a $525 billion defense budget that's around $6 billion less than current spending levels. These spending cuts have great potential to severely impact traditional military contractors such as Northrop Grumman (NYSE:NOC). However, as the U.S. begins to draw down its mechanized army, another "war" is brewing. This war of data breaches could be the best way to play future defense spending.

Investopedia Markets: Explore the best one-stop source for financial news, quotes and insights.

The Growing Problem in Cybersecurity
Assaults by criminals, terrorists and various "hacktivists" on our nation's computer systems continue to rise at a rapid pace. The modern world's reliance on computer networks grows more interconnected every day. From smartphone adoption and email to digital banking and credit cards, it seems that we use the web for more things than ever before. This extends into infrastructure that is essential to our economic security, such as power grids and water-treatment plants.

Recent data breaches at Sony (NYSE:SNE) and the International Monetary Fund (IMF), highlight the recent surge in hacker activity. A recent survey by McAfee showed that 43% of respondents identified disruption to critical infrastructure as the greatest single threat posed by cyber-attacks, and nearly 57% believe that a cyber space arms race is occurring. (For related reading, see 3 Ways Cyber-Crime Impacts Business.)

However, despite the growing need for preventing these sorts of attacks, actual spending and preparedness in the area is nonexistent. A recent survey by Bloomberg of network managers at 21 energy companies, found that these firms only spend an average of $45.8 million a year on IT security. The utilities surveyed are able to prevent around 69% of cyber strikes against their computer systems. However, analysts estimate that to prevent 95% of all attacks, it would take an average annual budget of $344.6 million per company.

To put that into context, the U.S.'s largest utility, Southern Company (NYSE:SO), only made around $277 million in profit last year. Nationwide, the U.S. would need to spend a total of $46.6 billion to prevent 95% of all attacks. That's up from the current $5.3 billion spent on cybersecurity.

Given how vital our infrastructure is to national security and under-funded nature of the sector, cybersecurity will undoubtedly get a larger share of the shrinking defense budget. Democratic Senate Majority Leader Harry Reid, is currently working on a comprehensive cybersecurity bill and various House Republicans are pursuing similar measures.

Playing the Spending Gap
With cyber threats continuing to mount and the reliance on computer networks growing, adding an IT security component to a portfolio makes sense. Both the PowerShares Aerospace & Defense (ARCA:PPA) and iShares Dow Jones US Aerospace (ARCA:ITA) follow some of the largest defense contractors and could be used as proxy for the defense sector. However, not all the firms such as Precision Castparts (NYSE:PCP) have any exposure to cybersecurity. It might make sense to go the individual route.

As more businesses, utilities and computer systems move into cloud computing, protecting that data becomes ever more important. Communications defense contractor Harris (NYSE:HRS) has been increasing its security offerings in the space and could be great way to play the need for secured data systems. Shares of the firm currently yield a healthy 2.7% and growth in its cloud security division has been robust. Likewise, both Sourcefire (Nasdaq:FIRE) and Websense (Nasdaq:WBSN) provide cloud computing security options and could be future buyout targets.

The Bottom Line
While the broad defense industry braces itself for major spending cuts, the number of cyber attacks continues to grow. Firms that operate in this area will see the bulk of future defense spending. The previous stocks, along with Symantec (Nasdaq:SYMC), make ideal choices to play the trend. (For additional reading, check out Tips For Keeping Your Financial Data Safe Online.)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

At the time of writing, Aaron Levitt did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  2. Mutual Funds & ETFs

    ETF Analysis: ProShares UltraPro Nasdaq Biotech

    Obtain information about an ETF offerings that provides leveraged exposure to the biotechnology industry, the ProShares UltraPro Nasdaq Biotech Fund.
  3. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI Europe Financials

    Learn about the iShares MSCI Europe Financials fund, which invests in numerous European financial industries, such as banks, insurance and real estate.
  4. Mutual Funds & ETFs

    ETF Analysis: SPDR S&P Insurance

    Learn about the SPDR S&P Insurance exchange-traded fund, which follows the S&P Insurance Select Industry Index by investing in equities of U.S. insurers.
  5. Mutual Funds & ETFs

    ETF Analysis: SPDR S&P Emerging Markets Small Cap

    Learn about the SPDR S&P Emerging Markets Small Cap exchange-traded fund, which invests in small-cap firms traded at the emerging equity markets.
  6. Mutual Funds & ETFs

    ETF Analysis: ETFS Physical Platinum

    Learn about the physical platinum ETF. Platinum embarked on a bull market from 2001 to 2011, climbing to record prices along with other precious metals.
  7. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI Turkey

    Learn about the iShares MSCI Turkey exchange-traded fund, which invests in a wide variety of companies' equities traded on Turkish exchanges.
  8. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  9. Mutual Funds & ETFs

    ETF Analysis: Guggenheim Enhanced Short Dur

    Find out about the Guggenheim Enhanced Short Duration ETF, and learn detailed information about this fund that focuses on fixed-income securities.
  10. Mutual Funds & ETFs

    ETF Analysis: iShares US Oil&Gas Explor&Prodtn

    Learn about the iShares U.S. Oil & Gas Exploration & Production ETF, which provides an efficient way to invest in the exploration and production sector.
RELATED TERMS
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Exchange-Traded Fund (ETF)

    A security that tracks an index, a commodity or a basket of assets ...
  3. Exchange-Traded Mutual Funds (ETMF)

    Investopedia explains the definition of exchange-traded mutual ...
  4. Hard-To-Sell Asset

    An asset that is extremely difficult to dispose of either due ...
  5. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  6. Lion economies

    A nickname given to Africa's growing economies.
RELATED FAQS
  1. 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 >>
  2. 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 >>
  3. What does a high turnover ratio signify for an investment fund?

    If an investment fund has a high turnover ratio, it indicates it replaces most or all of its holdings over a one-year period. ... Read Full Answer >>
  4. Does index trading increase market vulnerability?

    The rise of index trading may increase the overall vulnerability of the stock market due to increased correlations between ... Read Full Answer >>
  5. 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 >>
  6. 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 >>

You May Also Like

COMPANIES IN THIS ARTICLE
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!