Photographer: Eric Thayer/Bloomberg
(Bloomberg) — Time was, military contractors appealed to equity investors for their stodginess — predictable revenue, solid profit margins and reliable dividends. Times change.
While weaponry behemoths like fighter-jet maker Lockheed Martin Corp. and missile producer RTX Corp. still occupy a key corner of most stock portfolios, they’ve gotten some company of late — nimble upstarts more akin to technology firms with lofty valuations and the promise of rapid profit growth.
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The newcomers at the top of the rankings — in share price appreciation, if not yet market value — include drone maker Kratos Defense & Security Solutions Inc., satellite intelligence outfit Planet Labs PBC and data analytics company Palantir Technologies Inc. Each has seen its stock at least double this year. AeroVironment Inc. and BlackSky Technology Inc. have also offered strong returns.
Their ascent comes as the nature of warfare changes, most evident in Ukraine’s drone-led defense against Russia’s invasion. At the same time, US President Donald Trump has upended long-standing alliances, prompting nations across Europe and Asia to raise spending on their fighting forces and defense capabilities. Some of that money is expected to flow to US contractors.
This year has been a “new dawn in defense stocks,” said James St. Aubin, chief investment officer at Ocean Park Asset Management. “Defense was defensive for a long time, and that’s still true to some degree, but it is taking a new turn.”
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The upshot is that it’s been a good year to be an investor in military contractors and their suppliers. The S&P 1500 Aerospace and Defense group, home to 24 companies, is on its way to a 41% jump, the most since 2013, lifted also by strength in the commercial aerospace sector. That’s more than double the S&P 500’s advance, and some 16 percentage points ahead of the fabled Magnificent Seven tech behemoths.
European weapons makers like Germany’s Rheinmetall AG, Sweden’s Saab AB and Italy’s Leonardo SpA have also rallied as nations on the continent move to supercharge federal spending on their militaries.
In the US, old-guard companies like RTX and Northrop Grumman Corp. have notched double-digit advances. Investors have been enthusiastic about US military spending, as well as programs like the Golden Dome missile-defense effort. The possibility that the Trump administration will pressure defense contractors to cut buybacks and dividends has barely put a damper on excitement.
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Then there are the newcomers, plugging holes in the industry with high-tech systems and materials that make fighting more lethal and less manpower-intensive. Trump signed an executive order in June aimed at unleashing “drone dominance,” and Defense Secretary Pete Hegseth issued a memo on the same theme. Hegseth has told the largest contractors to speed up weapons development or “fade away.”
“There’s been a real specific push by the Department of Defense, basically under the mantra of getting technology to the warfighter faster, looking to really accelerate the contract awards and the business to smaller companies that are leaning more into technology,” RBC analyst Ken Herbert said.
‘Extreme’ Valuations
The group is not without its risks. Kratos and fellow drone maker AeroVironment gave tepid outlooks this quarter owing to some growing pains, and the shares were hammered in response. Skepticism of high valuations across the market has also fueled weakness, bringing AeroVironment down some 40% from an October record high.
All told, this year has delivered the kind of high-risk, high-reward rally not often seen in the defense sector, typically a staid corner of the market where investors can hide in a downturn.
“These stocks have been turbocharged because of what they do,” said Mark Malek, chief investment officer at Siebert Financial. “From a finance perspective, you can’t get upside unless you get risk.”
Even after the selloff, valuations for many of the companies remain elevated. Kratos trades at about 100 times the next 12 months’ estimated earnings. Palantir’s multiple, currently above 190, has long been a topic of debate on Wall Street. By comparison, RTX is valued at 27 times earnings and Lockheed, the granddaddy of them all, known for its C-130 Hercules transport plane, at just 16 times.
“These companies are trading at extreme multiples,” said Tony Bancroft, portfolio manager for the Gabelli Commercial Aerospace and Defense ETF, of Kratos and AeroVironment. “I like the markets they’re in. I believe the drones are going to grow. It’s just maybe not the sweet spot of where I’m looking to focus.”
‘Warfare Is Changing’
Others have no such misgivings. The smaller military contractors seem to appeal to a new breed of stock investor, one that embraces the type of risk more commonly seen in cryptocurrencies or artificial intelligence plays. It doesn’t hurt that many military technology companies have embraced AI, from Planet Labs’ image analysis to Palantir’s work on tools for finding battlefield targets.
Then there’s the Ukraine war, perpetually slated to end in US-led peace talks that continue to fall short. Even if there’s an accord soon, the conflict has “accelerated attention to how much warfare is changing,” Stifel analyst Jonathan Siegmann said.
Militaries are going to move their budgets away from traditional war equipment, such as tanks and other armored vehicles, and toward technology, said Benjardin Gaertner, head of equities at DWS Group, Deutsche Bank’s asset-management arm. Investors should shift their dollars accordingly, he said, adding that the change in governments’ priorities will benefit companies in the US and China disproportionately.
“The increased focus on non-traditional contractors makes sense,” JPMorgan’s Seth Seifman said in a Friday note, “though it requires a different approach than defense investors are accustomed to, with less focus on traditional valuation metrics, a greater need to understand individual programs and a smaller role for cash return.”
–With assistance from Isolde MacDonogh.
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