Key Takeaways
- European defense stocks have come under pressure this year after a record run in 2025.
- As the race to rearm continues, investors focus on actual revenue rather than governments’ spending pledges.
- Defense majors from Rheinmetall to BAE have further room to run, according to analysts, with several names in the sector undervalued.
Europe’s defense stocks are under pressure, with investors growing more discerning at the end of a dramatic rally last year. But, despite lofty valuations, analysts suggest the sector has further room to run.
Shares of defense firms Thales HO, Saab SAAB B and Renk R3NK all dipped more than 2% on first-quarter earnings, as solid results did little to jolt stocks from their recent rut, and ever-higher expectations mature from bumper spending to concrete execution.
With the case for European rearmament gaining pace since Russia’s 2022 full-scale invasion of Ukraine—and fresh war in the Middle East adding to global tensions—investors are now demanding to see the sector translate political momentum into sustained earnings growth.
“The 2026 year-to-date pullback looks like a healthy and overdue consolidation. Meanwhile, the fundamental drivers of Europe’s rearmament cycle remain firmly intact, supporting continued outperformance over the next 3–5 years,” Beat Wittmann, partner and chairman at Porta Advisors, says.
Bumper Defense Budgets Priced In
European defense stocks were trading near all-time highs at the start of 2026, having rallied over recent years on heightened geopolitical tensions and bolstered military budgets. Last June, NATO members committed to boosting defense spending to 5% of GDP annually through 2035, with 3.5% allocated to core military spending. Germany, Europe’s largest contributor, has vowed to hit that target by 2029.
According Wittmann, the recent dip therefore looks like healthy profit-taking as the cycle enters its next phase.
“European defense stocks have risen 3–5x since Russia’s 2022 invasion of Ukraine, making the sector the best-performing investment theme and outperforming both US and European equity indices by a wide margin,” he says.
Nevertheless, renewed macro pressures—including as a result of the Iran war—have also removed some momentum from the sector amid concerns that it could throw off execution timelines.
“European defense stocks (-11%) have underperformed the broad European market (-3%) since the first attack on Iran on 27 February 2026,” Paul Jackson, global market strategist for EMEA at Invesco, notes. “With the European defense sector on a PE of 36.9 (it was 45.0 on 27 February), I believe that investors are looking for governments to raise their military spending ambitions,” he says. "That will involve the placement of orders.”
First Quarter Earnings Give Early Read on Order Conversions
While analysts, including at Barclays, argue that risks to Europe’s rearmament agenda are overstated, investors are now squarely focused on companies’ progress in entering the next phase.
“Recent results have shown that Europe’s rearmament is stepping up as planned,” says Aarin Chiekrie, equity analyst at Hargreaves Lansdown.
The latest quarter is seen as a first read on companies’ ability to convert boosted defense budgets into higher revenue and increased industrial activity. Bumper backlogs are no longer enough; investors now seek assurances that firms can turn them into deliveries.
“After a very strong rerating across European defense stocks last year, investors are becoming increasingly discerning and shifting focus away from headline NATO spending commitments toward actual execution,” Morningstar equity analyst Loredana Muharremi says.
“The debate is no longer whether Europe wants to rearm—politically, that has already been established. The real question now is which countries can realistically sustain and operationalize higher defense spending over multiple years, and how quickly that translates into industrial output, revenue, and cash flow,” she adds.
Europe’s Most Undervalued Defense Stocks
As a result, investors are becoming more selective, seeking evidence of the companies best placed to ride that wave. In first-quarter earnings, names with strong electronics and systems portfolios, such as Saab, Thales and Hensoldt HAG, tended to beat expectations, while heavy industrial manufacturers like Rheinmetall RHM faced more scrutiny.
At EUR 1,172 as of Monday’s close, Rheinmetall is trading at a steep 53% discount to its fair value—the most among large European defense stocks. Still, Morningstar’s Muharremi retains a fair value estimate of EUR 2,380, noting that the structural drivers of demand and profit growth remain intact and visible well beyond 2026. Despite missing first-quarter expectations, the company forecast significant growth in the second quarter.
“Rheinmetall retains a strong exposure to the bloc’s biggest defense spender, Germany. It has a huge order backlog and is expected to grow revenue at high double-digit rates for the foreseeable future. While it will undoubtedly experience some bumps in the road as it looks to ramp up production at an eyewatering pace, the long-term direction of travel should remain earnings positive,” Hargreaves Lansdown’s Chiekrie says.
Hensoldt, which trades at a 29% discount, has established itself as a promising smaller German player, focusing on fast-growing segments such as radar, sensors and electronic warfare. Thales, Renk and Saab are among other discounted defense names, according to Morningstar’s analysts.
Elsewhere, BAE Systems BA, which trades at a 26% discount, is one of the few stocks in the sector that are up this year, and stands to benefit from further increases to US expenditures, according to Chiekrie. “BAE Systems looks well positioned if US defense spending ramps up, with nearly 45% of its sales coming from the US. Having large exposure to this market is proving very beneficial.”
Even with intermittent signs of detente between the US and Iran, and a prospective yet elusive peace deal for Russia and Ukraine, analysts see little change to those fundamentals in the years and months ahead, even as higher expectations are priced into the sector.
“Europe is accelerating its push for sovereignty across defense, technology, and capital markets. This will increasingly direct procurement toward systems that are developed, manufactured, and financed within Europe, creating a powerful long-term tailwind for the European defense sector,” according to Porta’s Wittman.
“A [Russia-Ukraine] ceasefire would not eliminate Europe’s rearmament need and could actually compress the timeline for rebuilding inventories, readiness, and warm industrial capacity before any future escalation cycle,” Muharremi says.
