The Hazards of Defense Industry Investment

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Still timely today, this piece on the defense industry offers some fascinating insight.

Like any industry, the defense industry as an investment has a lot of pitfalls the number one pitfall being excessive disclosure.

"Recommendations for stock purchases" said E. F. Hutton & Co.. Are obliged to include explanations of the innate hazards involved, and contract renegotiation considerations deserve particular mention when discussing the defense industry. Congress has been highly critical of Pentagon procurement policies, especially on the use of negotiated instead of fixed-price contracts and, as a result, the renegotiations law has always been short-term legislation."

Consequently, defense contractors have been subject to the uncertainties of possible refunds, aggravated by the fact that sometimes the Renegotiation Board consumed a long time in determining excess profits. (Some recent actions date back to 1952.) North American Aviation, for instance, has been cleared by the Renegotiation Board for 1956 and 1957, but the Board has claimed excess profits were realized in 1953, 1954 and 1955 which could require refunds to the government of $1.3 million, $5.5 million and $3.5 million, respectively, after tax adjustments, if sustained by the tax court.

The possibility of future refunds by North American Aviation and others, including Martin and Lockheed, should be recognized as one of the speculative aspects of the industry.

The industry, however, is hopeful of some favorable alterations in this practice, though its push for such alterations may lead, in the estimate of E. F. Hutton & Co., to "the tightening of policies in order to produce more accurate cost estimates from bidders and to reduce the possibility of tying up taxpayer's money, slated for the defense program, in drawn-out legal battles for excess profit refunds."

Another hazard inherent in the defense industry is the rapid shift in weapon emphasis there is such a thing as weapon obsolescence. In 1959, the Air Force had to drop its Goose decoy missile when the more advanced Quail (with the same aim of confusing enemy defenses) overtook it in development. "Our weapon plan is like a cornfield," said a Pentagon official. "We plant lots of seeds and later thin out those that aren't growing too well.

It is no secret that defense planners have, from time to time, examined what they call marginal weapons, especially those which would involve heavy spending in future years as they reach advanced stages of development.

There is, of course, a limit to American resources. The country could not possibly produce every missile or space project it researches and develops. Right now, for instance, no fewer than 25 space projects and sixty missile programs are in various stages of development. To develop all at the pace demanded by their programmers would swell the defense budget to such an extent as to be destructive economically.

You must know something about the nation's actual defense planning to know which weapon is marginal, though the trouble is compounded by the fact that weapons ratings change from day to day.

Worse still, most times, government planners fail to agree. Take for instance North American Aviation's B-70 bomber. The B-70 is a high-altitude, long-range supersonic bomber, planned as a replacement for the B-58 which forms the backbone of the Strategic Air Command. While its Air Force backers hailed the weapon as the "hottest bomber ever conceived," former Budget Bureau Director Stans flatly called it "a tremendously expensive development."

Its opponents further argued that it would fly too fast for accurate bombing. Another objection: the planes may be on duty too late to be of any use.

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