Investing in airport security

By Glenn Rogers, contributing editor Gordon Pape'sThe Internet Wealth Builder

Without meaning to be ghoulish, the attempted Christmas terrorist attack caused me to assess what stocks would benefit from increased attention by the Obama administration on this Homeland Security area

We are focusing on four stocks that we believe will benefit from these developments: L-3 Communications Holdings (NYSE: LLL), Cogent Systems (NASDAQ: COGT), American Scientific & Engineering (NASDAQ: ASEI) and OSI Systems (NASDAQ: OSIS).

L-3 has over 44,000 employees and operates in a large number of areas within the aerospace and defense sectors. The company offers solutions in secure communications, mobile satellite communications, shipboard communications, missile arming systems, radar and missile systems, and airport security equipment.

They also design and manufacture screening systems for explosives, firearms in airports, security checkpoints, and commercial buildings. So if you are looking for a company that covers the waterfront and everywhere else on the security front, L-3 might be for you.

The company has also become a large manufacturer of unmanned drones which are playing a significant role in the war in Afghanistan. L-3 looks to be a bedrock part of our arsenal going forward.

The company recorded earnings per share growth of over 24% in the third quarter and it is trading at a P/E of only 11.23. L-3 had revenues last year of almost $15 billion (all currency figures are in U.S. dollars). I am restoring L-3 to our Recommended List .

The next company on our list -- Cogent Systems -- is considerably smaller than L-3 and is more narrowly focused. Cogent creates systems and devices that track individuals and materials.

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The company's main business is producing automated fingerprint identification systems (AFIS). Its primary customers are the ones you would expect: law enforcement, government agencies, and large corporations. Cogent also manufactures systems that are used at border crossings, which is a high-need area worldwide.

Although the company is small, with only 137 employees and less than $90 million in sales, it operates internationally. The company showed strong growth in the second quarter as sales increased 131% year-over-year, to $39.4 million, and income grew at a blistering 96%.

What I particularly like about Cogent is that it maintains a high profit margin of 42.1%. However, third-quarter figures were not as bullish as non-GAAP net income came in at $6.3 million (7c per share) compared to $12.6 million or (14c per share) in the same year ago period.

Cogent also announced that its board has authorized a new stock buy-back program of $100 million, expiring on Nov. 12, 2010 to replace the program that expired last November.

The company's main source of revenue has been the U.S. Visit program, which helps to identify foreign visitors to the country, but the company also had 13 significant contracts near the end of last year with the U.S. Army, the U.K. Post Office, and the Belgian police. T

They also recently won a contract with the New York State Office of Temporary and Disability Assistance. Standard & Poor's maintains a buy opinion as does Marketing Edge. The company next reports earnings on Feb. 25 and analysts are predicting that they will raise guidance for 2010 at that time.

Meanwhile, two new recommendations ours, ASEI and OSIS, both of which will benefit from the ongoing counterterrorist efforts:

American Science and Engineering manufactures x-ray inspection equipment and other detection devices for Homeland Security and other countries around the world. They have equipment that can be used to inspect not only humans but also cargo containers, baggage, vehicles, etc.

This is a pure play on x-ray machines and the company has been flooded with orders from around the globe. For instance, they recently received a $39.7 million order for cargo x-ray inspection systems from an unnamed government agency and a $5.8 million follow-on order for cargo security equipment in the Middle East.

Understandably, the company and its customers are careful about how much information they release to the general public but suffice to say business is booming and is likely to continue doing so for the foreseeable future.

The company's profits are showing steady growth. Second-quarter 2010 earnings came in at $1.18 a share, up 42% from 83c in the same period last year. The stock has run up lately and is trading at 19 times forward earnings but I would still take a small position here and add to it on any pull-back.

Finally, owning shares in OSI Systems gives you x-ray equipment that competes with the companies that we discussed above along with the more traditional baggage equipment scanners that you are used to seeing in airports everywhere.

The company also has a Health Care division that specializes in patient monitoring cardiology diagnostics and anesthesia delivery. A third division, Optoelectronics, manufactures devices for the aerospace and defense industries. OSI Systems was recently written up in Barron's as a turnaround story and even after the recent run-up still trades at 18 times earnings.

The company has received a number of new contracts lately including a $3.2 million deal to provide security inspection systems at the Vancouver Winter Olympics. Their latest financial statement showed earnings per share of 14c compared to only a penny in the prior year.

In that report, OSI raised its 2010 earnings guidance to between $1.14 to $1.23 per share, which would represent year-over-year earnings growth of between 25% and 35%. They have a record backlog of $146 million.

The stock has almost tripled in value in the past year and closed on Friday at $30.69. I suggest taking a small position and watch for a pull-back to add more. OSI is trading near its 52-week high but terrorism is a long-term problem as is health care so OSI should continue to benefit over the long haul.

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