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President-elect Donald Trump will likely talk loudly and carry a big stick.

This should benefit defense stocks, including Northrop Grumman (ticker: NOC). The defense giant’s stock has rallied since the Nov. 8 presidential election and could trade even higher should the new administration increase defense spending.

After two days of meetings in Washington, Noah Poponak, Goldman Sachs ’ defense analyst, is advising clients that the sector—and especially Northrop—is poised to rally when Trump releases his proposed budget in January or February. Moreover, if the Republican-dominated Congress rolls back the sequestration budget-trimming program, defense spending could grow by more than 5% on average over the next several years.

Yet options pricing indicates investors are not focused on the budget, or the many defense contracts gathering dust in Pentagon offices that could suddenly be funded.

If this happens, Goldman is telling clients that Northrop Grumman is the best-positioned defense company that it covers. It has a stake in rapidly growing programs like the F-35 fighter jet, the Navy’s unmanned Triton surveillance aircraft, and the B-21 stealth bomber. The company is also a contender in major yet-to-be-awarded contracts, including the Ground Based Strategic Deterrent system, which would replace the Intercontinental Ballistic Missile system that protects America from nuclear missiles.

In anticipation, Goldman’s derivatives strategists are advising clients to buy Northrop Grumman’s May $250 call options, which cost $11.70 when the stock was trading at $247.84.

For the trade to prove profitable, the stock must enter a new trading range, which is a significant hurdle. Over the past 52 weeks, the stock has ranged from $175 to $253.80. Should the stock trade at $270, for example, the call is worth $20. The trade’s break-even is $261.70. Below that price, this trade fails.

The bank’s strategists, Katherine Fogertey and John Marshall, are recommending May calls, rather than February ones, to provide more time for Trump to submit his budget. The expiration should capture two earnings reports.

We last highlighted Northrop Grumman in August 2015. Back then, like now, the stock was flying under the radar. But Poponak saw value. He was telling clients that Northrop Grumman would win a $55 billion contract to build long-range strike bombers. He was right, and the stock has since surged. We’re willing to bet that he will be right again on Trump’s defense budget.

STEVEN SEARS is the author of The Indomitable Investor: Why a Few Succeed in the Stock Market When Everyone Else Fails.

Comments: steve.sears@barrons.com

Follow: @sm_sears

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