Cramer: Are Defense Stocks Buys or Overbought?

(Click here for video linked to a searchable transcript of this Mad Money segment)

A handful of defense stocks have roared higher over the past 12 months despite the sequester. What the heck is going on here?

"These stocks were supposed to keel over and die the moment the sequester went into effect," Cramer said.

Yet Northrop Grumman is up almost 40% and Lockheed Martin is up 21%. Both of these companies are highly dependent on spending from the U.S. government.

The gains don't make sense, do they? Did Northrop and Lockheed simply go along for the ride as the S&P spiked higher or are there fundamental reasons for the advance?

Jim Cramer did a little investigating and discovered the following:

U.S. military
Getty Images

"First of all, as time goes on, it's looking like the sequester worries were blown way out of proportion," he said. "This is a case where the analysts got way too negative and spooked investors with a slew of downgrades at exactly the wrong time."

And it seems that politicians are doing what they do best – kicking the can down the road. "That is, the government has been very slow to cut defense spending and has pushed out the big decisions until the end of the year," Cramer said.

The Mad Money host believes the longer these defense cuts are pushed out, the better the chance that they'll never happen.

"You have to understand the way this process works. Very few people in Washington actually want these defense cuts to go into effect. And if the President and Congress can actually pass a budget for 2014, or even just a supplemental defense budget, then that trumps the sequester."

In addition Cramer sees another catalyst.

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"There's the Quadrennial Defense Review coming up this summer, that's a big analysis of military priorities and requirements that the government conducts every four years, and it's likely to have a major impact on where the Pentagon's money actually goes for years to come," Cramer added. Recent gains may be a sign that the market expects Lockheed and Northrop to fare well.

On top of that Cramer thinks there's a more fundamental catalyst. That is, the Street has come to believe big defense companies can offset weakness by cutting costs and winning more international business.

All told, Cramer said it makes perfect sense for all these stocks to have rallied. And he thinks there's more room to run.

"I think it's not too late to buy Northrop Grumman because they have the cash and the scale to overcome even the worst case scenario. Same goes for Lockheed Martin, which sports a terrific 4.2% yield and posted a 29-cent earnings beat, off of a $2.04 basis, when it reported five weeks ago. While I'm concerned about higher yielding stocks in general, one that's cheap like Lockheed Martin doesn't worry me and instead is a terrific go to place to buy on weakness," Cramer said.

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