When we dissected the defense industry last week (Big Military Budget Means Big Boon for Small Defense Contractors), we alluded to a problem that made it difficult to specifically take advantage of swelling military budgets. In a nutshell, while there are dozens of military contractors out there, for most, military contracting is a minority of their business. Honeywell (HON), for instance, is the biggest company that provides hardware for the military, but the bulk of its revenue is driven from non-military industrial technology sales.

In an effort to be as specifics as possible - which is the difference between being a good and great investor - we’re introducing a new index today…. the MicroCapPress.com Small/Micro Cap Defense Index. The constituents are small and micro caps names with the majority of their business focused on military contracts.

Yes, it’s tightly focused, and no, there aren’t that many stocks in it. That’s precisely the point though.

While the index should be volatile given its nature, it should also be critically important to traders seeking to capitalize on an ever-increasing military budget. We expect that volatility to work to our advantage in spotting points in time when these stocks are making major turns - like now.

The MicroCapPress.com Small/Micro Cap Defense Index just pushed off a couple of important support lines…. one rising, and one horizontal. Though last week’s buying volume wasn’t as strong as the prior week’s selling volume, that spike from two weeks ago may also be signaling a pivot point. Take a look, but keep reading.

One of the advantages of maintaining indices with only a few stocks in it is that you can also keep tabs on the underlying fundamentals.… something most major industry and sector indices can’t do. With that said, here’s the current fundamental snapshot and list of stocks that make up this new index.

Note that Global Defense Technology (GTEC) will eventually be added to the index; more trading history is needed in order to seamlessly integrate it into the index calculations.

In any case, we see a reasonably valued group, with an even more compelling outlook. Though a P/E above 20 and an average margin of around 8% don’t seem all that healthy, that’s actually not too far off the norms (and better than many other industries). There’s no outright ‘deal breaker’ in terms of fundamental data, anyway.

No matter what, this should be an interesting index to follow over time.

By the way, don’t forget we introduced the Small/Micro Cap Video Gaming Software Index earlier in February. These two are just a couple of the many we plan on rolling out in 2010 as we strive to help fine-tune your navigation of the small and micro cap market. Stay tuned for more micro cap index rollouts as merited.

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