A Rheinmetall plant on the outskirts of Düsseldorf is operating longer shifts than it has in thirty years. Workers pass piles of shell casings kept in lots that were only partially occupied a few years ago. You wouldn’t have thought of such a scene in, say, 2018 in Europe. Defense was the unpopular sector of the market that no one seemed to want back then, and courteous investors only mentioned it in passing. The majority of people are unaware of how drastically that has changed.
By 2035, NATO members have committed to allocating 5% of GDP to defense, with 3.5% going toward hard military capability and the remaining amount going toward infrastructure and related projects. When you sit with it, the figure is astounding. Almost $1.59 trillion is anticipated to be spent by the alliance as a whole, and that money needs to go somewhere. Investors seem to think that a sizable portion of it won’t go to American primes the way it used to, and I believe they are right. A minor but significant development was Sweden’s recent $4 billion package, which was almost entirely given to European suppliers. U.S. contractors received zero dollars. You can infer everything about the continent’s mood from that particular detail.
This leads me to the three stocks that consistently come up in discussions with fund managers, analysts, and the occasional former procurement official who is eager to talk over coffee in Brussels.
Rheinmetall is the first. The German manufacturer’s share price has multiplied multiple times since 2022, making it something of a poster child for the rearmament cycle. Some claim it’s already priced for perfection, and they might be right. However, ammunition lines are growing, the order book continues to grow, and Germany alone has committed to a $127 billion defense budget for 2026—more than double what it spent the year prior to Russia’s invasion of Ukraine. It’s difficult to ignore Rheinmetall’s consistent conversion of political promises into contracts.
The second is BAE Systems, a British mainstay that has stealthily advanced through each of the previous four decades’ defense cycles. Despite a wider cooling of European defense stocks in March, when profit-taking and worries about the efficacy of drone warfare caused the sector to fall nearly 10% in a single month—the worst monthly decline in five years—its ADRs are up more than 30% this year. BAE dismissed it. It signed a $180 million contract with Sweden last month, and its work on electronics, combat vehicles, and submarines gives it a level of diversification that pure-play missile manufacturers do not. Analysts believe BAE is still cheap in comparison to its order pipeline, which is significant in an industry where multiples are stretched.
The third name is Leonardo, an Italian company whose shares listed in Milan have increased by 25% this year while its unsponsored ADR has increased by 13%. Leonardo’s wider portfolio in electronics, aerostructures, and cybersecurity exposes it to the less glamorous but increasingly significant areas of defense. Earlier this year, the company signed a $1 billion helicopter contract with the United Kingdom. Investors are stealthily making their way here in search of the rearmament narrative without just stepping up their attacks on Germany.
All of this carries some risk. Following the start of the Iran conflict in late February, defense stocks saw a roughly 11% decline due to concerns about execution timelines and stretched valuations. The European defense industry is still pricey by historical standards, but it is currently trading at a P/E of about 36.9, down from 45 earlier this year. Bumper backlogs are no longer sufficient on their own. Investors want deliveries, signed contracts that generate income, and bustling factory floors.
Whether all NATO members will adhere to the discipline required by 5% of GDP is still up in the air. Spain is not a signatory. Patriot batteries cost $1 billion each, so smaller nations are secretly negotiating with Israeli and South Korean suppliers. The headlines don’t accurately reflect the complexity of the cycle. However, observing this from a distance gives the impression that Europe’s defense moment is more than just a quarter of the story. This kind of structural change takes ten years to manifest, and Rheinmetall, BAE, and Leonardo appear well-positioned to be there when it does.
