How Indian Defence Stocks are Shaping Up for 2024

India's defence spending ranks among the top five globally. With recent increases in India's defence spending, it wouldn't be surprising if India breaks into the top 3.

At US$ 74 billion in FY24, defence spending represents a significant portion of the country's GDP.

The government's focus on promoting domestic defence equipment manufacturing offers a favourable environment for defence stocks to thrive.

The Indian military is undergoing modernisation, driving demand for defence products and services. This increased demand provides growth opportunities for many kinds of defence companies in India.

That being said, it's important for investors to understand that investing in the best defence stocks to buy in India is tricky. You see defence sector stocks are influenced by economic conditions and market fluctuations, as much as there are influenced by the government's decisions.

You need to look out for fundamentally strong defence companies to make the most of this opportunity. Picking the wrong stocks can result in major losses.

So how are these stocks shaping up in 2024?

The Core Reason to Remain Bullish on Defence Stocks

The major geopolitical events of the last few years, including the tensions on our borders, has made one thing clear to the government and our armed forces: India has to be self-sufficient in defence.

In an increasingly chaotic geopolitical world, the best defence for India is to arm itself with equipment, ammunition, and technology, produced within the country. Being dependent on defence imports from any country can prove to be a disaster during a war.

Being self-sufficient in defence will also go a long way to mitigate the effect of sanctions placed upon the country during a conflict.

The Government's Continued Support

Defence wasn't always a high growth sector. In fact, until 2018, the defence sector was suffering from low growth.

But the trend has reversed now. The sector has the government's full support as far as funding is concerned and there are certain policy tailwinds too.

With the government's spending on defence expected to go up further, 2024 is expected to be a good year for these stocks.

The government's aim is simple. It wants to modernise and sufficiently equip the armed forces to successfully fight a two-front war against Pakistan and China. The specific focus is to close the gap in defence capability with respect to China.

This thrust has combined multiple factors ranging from developing indigenous technologies, establishing a robust domestic manufacturing ecosystem, implementing structural reforms, and enhancing overall combat strength.

The last point, enhancing overall combat strength, is where the investing opportunity lies. This point is the focus of the government's ever increasing defence spending.

The Outlook for the Defence Sector in 2024

Much will depend on the upcoming Union Budget 2024. If the government's spending on defence were to rise in a significant manner, these stocks will rally.

However, it's important to keep in mind that the budget will be an interim one due to the upcoming general elections. Thus, it wouldn't be appropriate to expect major changes.

However, the government is likely to at least make some announcements related to defence. It's just a question of what exactly will be mentioned in the budget related to defence.

Another thing investors will have to watch out for is exports. The government is determined to make India a major defence exporter in the world.

The stock market is acutely aware of this. If any listed firm were to make an announcement in this regard, it's share price is likely to jump. This will happen with or without any meaningful increase in the defence spending in the upcoming budget.

Thus, investors in top defence stocks should not worry too much on a specific number in the budget or on any specific policy decision. The steady growth of fundamentally strong defence companies is enough to create wealth.

In the pursuit of buying such stocks, investors should be careful to not end up with dubious contenders.

Here're are three points highlighted by Tanushree Banerjee, co-head of research at Equitymaster, that you should look at when considering how to invest in defence stocks.

• Ratio of sales to orderbook: Execution is key to the potential of defence companies' wealth creating ability. Hence while bulging order books are great, you must keep a watch on whether the order book is converting to sales as planned.
• Ratio of receivables to sales: Defence behemoths were never a part of StockSelect recommendations until 2018.
  
  The reason? The stocks never met my safety criteria due to the massive backlog in payment receipts from the government. The receivables to sales ratios were always high. Without comfort on cashflows I didn't find them investment worthy.
  
  Defence behemoths like Bharat Electronics and Hindustan Aeronautics had a massive fall in their receivable days since 2018. And this is when the stocks came in my radar.But going forward too it would be important to evaluate the stocks based on this critical criterion.
• Asset turnover ratio: When you look for defence stocks, you need not go only for companies with the biggest capex plans or the largest order book. Rather you could also consider business that have the fastest conversion of assets to sales.

We believe this is a good checklist to use when evaluating defence stocks in 2024. These stocks are looking good based on their fundamentals and growth runway but it's important to be selective. Not all defence stocks are equally good.

You need tools to create a defence stocks watchlist for yourself. Check out the free Equitymaster Screener. Here apart from getting access to readymade watchlist following various themes you could also create your own watchlist.

Alternatively, you can use Equitymaster's ready-made hotlists for defence stocks:

• Fastest Growing Defence Stocks
• Multibagger Defence Stocks
• Fundamentally Strong Defence Stocks
• Undervalued Defence Stocks
• Debt Free Defence Stocks
• Best Defence Midcap Stocks
• Best Defence Smallcap Stocks

Tanushree Banerjee tracks defence stocks closely at Equitymaster. Watch her video on India's little known defence tech stocks.

Happy investing.

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. Learn more about our recommendation services here...