In the present-day geopolitical environment marked by increasing conflicts, defense stocks have become favorites among investors. General Dynamics (GD), the fifth-largest defense contractor in the United States and the world, has nearly doubled its stock price over the past three years. In December of 2022, the stock even reached an all-time high of $256.86. While it saw a decline afterward, especially in the first half of 2023, it has been recovering since, with a recent surge due to the outbreak of the new Middle East conflict.

The stock could continue its ascent, as some analysts consider it undervalued. The company also possesses defense products that are expected to be in high demand in the coming years. The Wall Street analyst community has a cautiously positive view of the stock, with an average target price of $266.52 for the next twelve months, representing a roughly 10% increase from the current price. Of the 24 analysts covering the stock, 15 recommend buying it, with two "overweight" ratings. Seven analysts suggest holding the stock. Currently, there are no sell recommendations or "underweight" ratings.

Among the defense systems produced by General Dynamics that are expected to be in high demand in the coming years are battle tanks, nuclear submarines, and missile destroyers. Although the US Army possesses 2,000 M1A2 Abrams battle tanks, which have been built by GD since the 1990s, these tanks are increasingly proving to be inferior to opposing weapon systems. The latest cannons on Russian tanks T-90 and T-14, as well as portable anti-tank missiles like the "Kornet" and even the Iranian-Russian low-cost drones of the "Geran-2" type, outmatch the Abrams armor. General Dynamics has introduced improved new versions, potentially leading to significant orders.

General Dynamics' Electric Boat division is traditionally the leading manufacturer of submarines for the US Navy. Russia and China are rapidly introducing numerous new nuclear submarines, which many military experts consider superior in various ways to American models. The US government may find it necessary to order more and more advanced submarines from GD at shorter intervals, particularly to expand the limited American capacity for submarine construction. The company also produces Arleigh Burke-class missile destroyers, which will likely remain one of the most crucial ship classes for the US Navy for many years – partly because the planned successor class, the Zumwalt-class, simply did not perform as intended. Therefore, General Dynamics manufactures numerous weapon systems that are critically important for the United States, but in which the country has fallen behind its key competitors technologically. This means that the US government will likely need to invest significantly in these areas, from which General Dynamics should greatly benefit since there are virtually no other US companies with the necessary know-how and capabilities in these weapon systems.

GD also operates in civilian sectors, including Gulfstream, a business jet manufacturer that has introduced the G800, an aircraft with the longest range for business travelers at 8,000 nautical miles. Despite corporate commitments to green transformation, the market for business jets is robust. It is expected to grow from $32 billion in 2021 to an estimated $35 billion by the end of this year. General Dynamics maintains a book-to-bill ratio of 1.4:1 in its aerospace business, indicating more orders than deliveries.

Especially considering the fact that the US has lagged behind Russia and China in terms of defense technology and that NATO, due to the Ukraine conflict, has largely depleted its stockpile of military equipment and, most notably, ammunition, which could continue in the new Middle East conflict, it can be expected that US defense spending will continue to rise. General Dynamics ended the third quarter, for which the figures have just been released, with a record-high order backlog of $95.6 billion.

The financial situation also appears promising. In the third quarter, revenues increased by 6% to $10.6 billion compared to the same period last year. While earnings per share decreased by just under 7% to $3.04, it surpassed the consensus estimate of $2.91. The net cash flow from operations was also above expectations at $1.35 billion, compared to the estimated $1 billion. The estimated volume of the entire business resulting from orders at GD is projected at $132.9 billion – this is equivalent to the revenue of three fiscal years. However, it doesn't appear as if there will be positive surprises for the full year. The management expects earnings per share between $12.60 and $12.65 for the full year 2023, while the consensus estimate is $12.59. Thus the company needs to earn $4.20 per share in the fourth quarter, while the market expects earnings of $4.33 per share in the fourth quarter.

Nevertheless, based on key financial ratios, General Dynamics' stock does not appear to be cheap. Its forward price-to-earnings ratio (P/E) is 20.3, and compared to other large defense companies, the stock is relatively expensive. Lockheed Martin, the largest US defense contractor, has a P/E of 16.4, as does Northrop Grumman. RTX (formerly Raytheon), on the other hand, is much more expensive with a P/E of 36.4. And GD also faces challenges. For instance, its shipbuilding and submarine division has the lowest operating margin at 7.3%.

However, the Combat Systems division of GD, which builds the Abrams tank, saw its sales growth accelerate to 14.5% in the first nine months, representing the highest growth in a segment. And the company has successfully reduced its debt, which now stands at 46.4% of equity, compared to 56.5% at the end of 2022.

The net debt level is now $7.9 billion, down from $9.3 billion at the end of 2022. For US investors, who are accustomed to large technology companies with no debt, this is still a substantial amount.

The company is poised for further growth, as the US government heavily relies on General Dynamics and needs to allocate a considerable amount of funding in these critical areas. However, investors should also keep an eye on the national debt, which is increasing at a rapid pace, raising questions about how long the US government can maintain its spending course.