The Russia-Ukraine conflict drags on, with Russia’s military machine bogged down by Ukraine’s asymmetrical tactics. Central to Ukraine’s fighting approach is guerilla warfare supported by unmanned aerial vehicles (UAVs), more commonly known as drones.

The raging conflict in Eastern Europe appears to be a no-win quagmire for both sides, but I detect at least one big winner: drone makers, exemplified by AeroVironment (NSDQ: AVAV). Your portfolio needs exposure to the aerospace/defense sector; AVAV is an optimal choice.

AeroVironment also is a play on the artificial intelligence (AI) bonanza. With AVAV, you can simultaneously leverage massive global defense spending and the hottest tech trend available.

The U.S. military is currently developing AI-operated drones that are cheaper and more precise than big ticket items such as combat jet fighters. The Pentagon’s aggressive push for AI-driven drone technology is changing the rules of the battlefield.

This AI-fueled trend in the military also is opening new opportunities for smaller cap tech companies to compete with mega-cap behemoths such as Lockheed Martin (NYSE: LMT).

AeroVironment is based in Arlington, Virginia, smack dab in the heart of Washington’s military-industrial-lobbying complex. The company has been accelerating its AI and autonomous initiatives as it develops new AI-centric prototypes, ultimately for use by the Department of Defense and intelligence agencies.

AeroVironment’s web site describes its AI research and development this way:

“[Our] software performs high-volume, automated analysis of still and video imagery from a broad spectrum of sources, including satellites, unmanned aircraft and fixed cameras, to detect specific objects, perform change detection assessment or discern ‘pattern of life’ activity.”

AI already is present on the battlefield. Notably, the Patriot missile system, which Ukraine has obtained from the U.S., features automated operations with human-in-the-loop override. But drones guided by AI are a quantum leap forward in capability.

Global defense budgets are soaring, but the obvious investment plays (e.g., the huge U.S.-based defense contractors) have already enjoyed a big run-up in price. The same principle applies to AI investing. The well-publicized choices, such as software and chipmaking giants, have capitalized on the buzz and their shares have gotten pricey.

The global drone wars…

Also creating tailwinds for the drone industry is America’s withdrawal from Afghanistan. It has been more than 20 years since Al-Qaeda’s 9/11 terrorist attacks on America, planned and guided from Afghanistan, that brought in U.S. forces that dislodged the Taliban from power and temporarily drove out Al-Qaeda. But the U.S. presence remains in that region, in the form of drones.

Just as the quagmire of a bygone era, the Vietnam War, was called “the helicopter war,” these regional engagements rightfully could be called “the drone wars.”

The U.S. continues to carry out counterterrorism drone strikes in countries around the world that are not conventional war zones, including Somalia, Yemen and areas bordering Afghanistan. The Pentagon doesn’t have boots on the ground in these hot spots, but instead of uniformed human beings, high-tech weaponry is doing the job, especially drones.

And therein lays a huge investment opportunity…and it seems to be one that Wall Street is missing.

Imagine if you had the prescience, back in the early 1960s during the beginning of America’s direct involvement in Vietnam, to increase your investment exposure to helicopter makers. In my mind, a similar situation exists with drone makers in the context of today’s warfare.

The conflicts in Eastern Europe, the Middle East, and Central Asia are huge profit catalysts for the drone industry, and the financial media are hardly paying attention.

With America’s official withdrawal from the “graveyard of empires,” the Pentagon has set up adjacent bases for troops, drones, bombers and artillery to keep the Taliban at bay, and conduct surveillance of other extremists.

In Ukraine, drones from the U.S. and Western allies are helping the outnumbered Ukrainians repel the much larger Russian invasion force. NATO member Turkey, in particular, has been providing Ukraine with highly effective drones.

AeroVironment, the world’s leading manufacturer of UAVs, is your best bet on this fast-growing industry. With a market cap of $2.5 billion, the company boasts a pipeline stuffed with autonomous flying vehicles that the military brass covets. The company is working to infuse AI capabilities throughout its product line.

But it’s not just war-fighters. Drones also pervade the commercial sector, as reflected by Amazon’s (NSDQ: AMZN) big investment in drone delivery. AeroVironment is a major military contractor but it would benefit the most from the mainstreaming of small-scale civilian drones, because these miniaturized UAVs are its specialty.

The following chart depicts the enormous multi-year growth ahead for commercial drones:

AeroVironment’s forte is making small and nimble UAVs that have the ability to carry payloads and are fitted with GPS systems and contact avoidance systems. These are the types of units that would help Amazon’s Jeff Bezos realize his bold vision of delivering packages door-to-door via drones.

Other major retailers are getting into the drone delivery business as well, especially in the wake of a pandemic that accelerated the transition to remote shopping.

Hunter-killers…

Pilot-less drones are revolutionizing the projection of power around the world. Republican and Democratic presidents alike have widely deployed “hunter-killer” drones in combat theaters overseas. Since the terrorist attacks of 9/11, every U.S. administration has initiated big hikes in spending on drones.

Drones also provide a way for politicians to deploy aggressive military action, while also limiting casualties among U.S. troops. Fact is, a drone is always willing to die for its country.

AeroVironment offers a broader array of UAV products than any of its competitors, especially ultra-sophisticated drones predicated on nanotechnology.

Added incentive for investors is AVAV’s appeal as a takeover target. We’ve been seeing an explosion in merger and acquisition activity this year, notably in industries such as aerospace/defense.

A deep-pocketed, mega-cap military contractor such as Lockheed Martin or Raytheon Technologies (NYSE: RTX), both of which also make drones, could seek “innogration” (internally integrated innovation) by purchasing the smaller AeroVironment. Indeed, AVAV and LMT already pursue joint ventures in drone development. A buyout of AeroVironment would hand AVAV shareholders a windfall.

Cold War II…

The Pentagon announced on Monday that it would buy thousands of drones and other autonomous devices over the next two years, for “multiple domains,” which means in the air, on land, and at sea by the Air Force, Navy, Army and Marines. Military officials said that they are seeking small, less-expensive drones enabled with leading edge technologies such as AI.

International conflict is likely to increase this year, as Russia, China, North Korea and other antagonists of America test the resolve of the Biden administration. When the world becomes more dangerous, defense contractors get more money.

The intensifying Russo-American rivalry will be a driver of defense spending, this year and beyond. Welcome to Cold War II.

According to data from the Stockholm International Peace Research Institute, the U.S. remains the world’s largest arms exporter, currently accounting for 37% of global arms sales.

AeroVironment’s UAVs provide a range of military and civilian functions and feature such evocative names as Raven, Wasp, Puma and Switchblade. The company also makes “green tech” systems for cleaner, more efficient transportation and energy production, a growth area as nations implement policies to fight climate change.

A “drone caucus” has emerged in the halls of Congress that fiercely protects UAV funding and touts these futuristic aircraft as a way to help save money on defense, better patrol America’s borders, and assist law enforcement agencies in surveillance.

UAVs have become a ubiquitous feature on the 21st century battlefield. In the military sector, UAVs also benefit from the trend towards information warfare and net-centric systems. UAVs are a crucial component in the emergence of intelligence, surveillance, and reconnaissance (ISR).

Coming to your neighborhood…

According to the aerospace/defense consulting firm Teal Group, a massive civilian and para-public UAV market will emerge over the next decade, as increasing numbers of federal organizations such as the Coast Guard, Border Patrol and even the Forestry Service require airborne surveillance and monitoring systems. Local law enforcement organizations in countries around the world use drones for policing functions.

Individuals are taking to drones as well, for personal use. The number of consumers registering drones and applying for drone pilot licenses has soared, according to the Federal Aviation Administration (FAA). The agency is bracing for the likelihood of millions (yep, millions) of unmanned aircraft filling the nation’s skies.

In addition to a booming number of commercial uses for drones, such as agriculture, pipeline inspection and Hollywood film-making, scores of hobbyists are buying drones at local stores or online and taking to the skies with a passion.

NASA is working with the drone industry and the FAA to forge a new low-altitude air traffic control system specifically for drones. It’s the rise of a new subculture, spelling big future profits for AeroVironment.

AeroVironment falls just beneath the outer limit of being a small cap, which affords it greater growth potential than its rivals such as Lockheed Martin (LMT’s market cap: $113.9 billion). The global economy is expected to pick up steam in 2024; economic growth especially benefits small- and mid-caps companies.

The average analyst expectation is for AVAV’s year-over-year earnings growth to jump 360% in the third quarter and 106.3% for full-year 2023. The stock’s 12-month forward price-to-earnings ratio is a bit pricey at 39, but not seriously out of whack with its growth prospects, especially in light of earnings growth projections.

Momentum is on AVAV’s side…

AVAV currently hover above its 200-day moving average, a sign of upward momentum. The 200-day moving average represents the average closing price over the past 200 days. The moving average gives us a clue as to whether the trend is up or down; it also identifies potential support or resistance areas.

AVAV’s Relative Strength Index (RSI) stands at about 49. RSI is a momentum indicator that measures the magnitude of recent price changes to analyze overbought or oversold conditions. The RSI provides short-term buy and sell signals; a reading below 50 is generally bullish.

AVAV occupies the nexus of the aerospace and technology sectors. Looking for a tech-oriented investment that won’t crash and burn? AVAV provides outstanding growth potential, without excessive valuation.

There’s more to making money on artificial intelligence than buying overpriced Silicon Valley giants. AVAV is a play on AI mania, but most people haven’t heard of the stock…yet. When you see AVAV featured on CNBC, it’ll be too late to strike.

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John Persinos is the editorial director of Investing Daily.

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