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Airlines, arms makers best for shareholders

– Aerospace companies and airlines are producing better returns than any other U.S. industry this year, helped by a rally in weapons makers such as Northrop Grumman and Lockheed Martin.

The two industries are the best performers among 68 groups in the Standard & Poor’s 500 Index when adjusting for volatility, beating groups such as biotechnology and Internet retailers, the Bloomberg Riskless Return Ranking shows. Northrop Grumman rose the most, with a risk-adjusted gain of 4.2 percent and volatility that’s about 20 percent less than the average for producers of military and commercial aircraft.

While American lawmakers reduced spending amid troop withdrawals from Iraq and Afghanistan, defense companies have responded by cutting their staffs and using cash stockpiles to buy back stock and increase shareholder payouts. The top five U.S. weapons makers, a group that also includes Boeing, General Dynamics and Raytheon, raised their earnings forecasts in October as cost cutting helped them boost profit margins.

“Everybody is streamlining and maximizing profitability as the outlook for defense spending declines,” said Brian Ruttenbur, an analyst with CRT Capital Group in Stamford, Conn. “Cash flows are at record levels, and the companies are deploying those cash flows back to shareholders.”

Northrop shares have rallied 63 percent this year, on pace for the best annual performance since the records began in 1980. Historical volatility for the Falls Church, Va., company was 16.1 in 2013, compared with 20.1 for the average S&P 500 stock in the aerospace or airline industry, according to data compiled by Bloomberg and released this month.

Lockheed and Raytheon have risen more than 50 percent this year with volatility below the group average, producing a risk- adjusted return of about 3 percent for both companies.

Airlines did best, with a risk-adjusted gain of 3.7 percent, followed by aerospace and defense industries, with a 3.4 percent risk-adjusted return. The airline group has only two members, Southwest Airlines and Delta Air Lines.

The risk-adjusted return, which isn’t annualized, is calculated by dividing total return by volatility, or the degree of daily price variation, giving a measure of income per unit of risk. Higher volatility means the price of an asset can swing dramatically in a short period, increasing the potential for unexpected losses.

Investors piled into defense shares this year, taking advantage of cheap valuations amid a budget standoff in Washington that led to Pentagon cuts totaling $500 billion over a decade. Government officials have shielded major weapons systems from cancellation since the reductions took effect in March, opting to delay maintenance work and scale back troop exercises instead.

“The cuts haven’t been nearly as bad as the companies warned they would be,” said William Loomis, a Baltimore-based analyst at Stifel Nicolaus & Co. “There haven’t been many significant contractor reductions. There’s definitely some relief around that.”

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