The government’s focus on domestic defence equipment production creates a promising environment for defence-related stocks. The ongoing modernization of the Indian military is fuelling the demand for defence products and services, opening up growth avenues for various defence companies in India.
That said, investors should note that defence stocks in India can be complex investments. These stocks are subject to economic conditions, market variations, and government decisions. It’s crucial to choose fundamentally strong defence companies to maximize investment potential and avoid significant losses.
Looking ahead to 2024, what’s the outlook for these stocks?
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The fundamental reason for optimism in defence stocks
Recent geopolitical developments, including border tensions, have underscored the need for India’s self-reliance in defence. In a volatile geopolitical landscape, India’s best strategy is to equip itself with domestically produced arms, ammunition, and technology.
Relying on defence imports could be catastrophic in wartime situations.
Self-sufficiency in defence also helps mitigate the impact of sanctions during conflicts.
Government support
Prior to 2018, the defence sector experienced low growth. This has since changed, with the sector now enjoying robust government support in terms of funding and policy. With anticipated increases in defence spending, 2024 looks promising for defence stocks.
The government’s goal is clear: to modernize and sufficiently arm the forces for potential conflicts against Pakistan and China, focusing on closing the defense capability gap with China. This involves developing indigenous technologies, establishing a robust domestic manufacturing base, implementing structural reforms, and enhancing overall combat capabilities.
The last point, enhancing combat strength, presents significant investment opportunities, driven by increasing defence expenditures.
Defence sector outlook for 2024
The upcoming Union Budget 2024 will be crucial. If defence spending increases significantly, these stocks are expected to rally. However, given the interim nature of the budget due to impending general elections, major changes may not be forthcoming. Still, defence-related announcements are anticipated.
Additionally, investors should watch out for export developments. The government aims to position India as a major defence exporter. Any related announcements from listed firms could positively impact their share prices, irrespective of changes in the budget.
Therefore, investors in top defence stocks need not overly focus on specific budget figures or policy decisions. The steady growth of fundamentally strong defence companies should suffice for wealth creation.
In choosing these stocks, investors should be cautious of unreliable options.
Tanushree Banerjee, co-head of research at Equitymaster, suggests three critical factors to consider for investing in defence stocks:
Sales to orderbook ratio: It’s essential to monitor if the orderbook effectively converts into sales.
Receivables to sales ratio: Defence behemoths were never a part of StockSelect recommendations until 2018.
The reason? Historically, high ratios due to delayed government payments made defence stocks less appealing. However, companies like Bharat Electronics and Hindustan Aeronautics have seen a significant reduction in receivable days since 2018, warranting investor attention.
Going ahead, assessing this ratio will continue to be important.
Asset turnover ratio: Investors should consider companies that efficiently convert assets into sales, rather than only focusing on those with the largest capex plans or order books.
While fundamentals and growth prospects for defence stocks appear strong, it’s vital to be discerning, as not all stocks offer equal potential.
Happy investing.
This article is syndicated from Equitymaster.com
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