Executive Summary

Aerospace‑ and defense‑related equities have outperformed broader markets in 2025.  The S&P Aerospace & Defense Select Industry Index is up around 44 % year‑to‑date, far exceeding the S&P 500’s ≈ 10 % gain .  Several catalysts explain this resilience:

• Robust government budgets.  Europe’s collective defense outlays climbed 19 % year‑over‑year to €343 billion ($402 billion) in 2024 and are expected to reach €381 billion in 2025, exceeding China’s budget and making Europe the second largest military spender after the United States .  U.S. spending is also expanding; the “One Big Beautiful Bill” (OBBB) includes $156 billion in additional funding for modernization  and lifts the total U.S. defense budget to roughly $849 billion .
• Growing investment in equipment and R&D.  Equipment purchases and R&D accounted for 31 % of EU spending in 2024; equipment spending jumped 39 % and R&D grew 20 % .  The EU and NATO aim to meet or exceed the 2 %‑of‑GDP pledge, with Poland, Lithuania and Latvia spending over 3.5 % of GDP .
• Tension‑driven demand.  Russia’s war in Ukraine, persistent tensions around Taiwan and the Middle East, and rising cyber threats are driving governments to replenish munitions, invest in next‑generation aircraft, drones and hypersonic weapons, and improve cybersecurity.  Europe’s rearmament is particularly pronounced—countries such as Germany, Poland and Sweden boosted spending more than 10 % in 2024 .

Against this backdrop, we evaluate six U.S. defense contractors—four large primes (Lockheed Martin, Raytheon Technologies/RTX, Northrop Grumman and General Dynamics) and two smaller innovators (Kratos Defense and AeroVironment).  The goal is to seek balanced exposure to stable cash flows and high‑growth niches.

Sector Dynamics and Investment Implications

Macroeconomic and Policy Environment

1. Surging global budgets.  SIPRI and IISS data show global military spending reached $2.46‑2.7 trillion in 2024, rising about 9 % in real terms .  Europe’s spending jumped 11.7 % in real terms to $457 billion .  These increases reflect elevated threat perceptions, easing inflation, and legislative support such as the OBBB in the U.S.
2. Steady revenue streams.  Governments are essentially the sole clients for defense primes; long‑term contracts and milestone‑based payments ensure reliable cash flows even during market downturns.  The OBBB, for instance, funds shipbuilding, aircraft, missile defense and munitions through 2029 .
3. Risk factors.  Despite robust growth, investors should monitor geopolitical escalation (disrupting supply chains), inflationary pressures, regulatory hurdles linked to large budget bills and market volatility .  Additionally, the debate over classifying defense investments as ESG‑compliant is intensifying ; negative sentiment could influence capital flows.

Valuations and Performance

• Sector valuation.  The strong YTD rally has raised valuation multiples.  However, many primes still trade at or below market averages.  For example, Lockheed Martin’s forward P/E of 17.86  and General Dynamics’ forward P/E of 20.89  are lower than the broader industrials sector.  Raytheon’s forward P/E of 26.83  is higher but reflects its growing commercial aerospace exposure.  Smaller names have stretched valuations: Kratos trades at a forward P/E of 133  and AeroVironment at ≈ 71 , implying high expectations for future earnings.
• Dividend yields and cash returns.  Large primes typically provide 2–3 % dividend yields and repurchase shares, offering income and reducing share counts (e.g., Lockheed’s shares outstanding fell 3.24 % YoY ).

These dynamics support a barbell strategy: overweight the cash‑generating primes to anchor the portfolio while allocating a smaller portion to agile innovators to capture outsized upside from emerging technologies (e.g., drones, autonomous systems).  Below we assess each company.

 

Company Analyses

 

Lockheed Martin (LMT)

Business overview. 

LMT is the world’s largest defense contractor.  Its portfolio spans F‑35 fighter jets, hypersonic weapons, satellites and missile defense systems.  About 70 % of revenue comes from the U.S. government , ensuring stable cash flows.

 

Financial performance and backlog. 

In Q1 2025 sales grew 4 % to $17.9 billion, driven by a 13 % increase in the Missiles & Fire Control (MFC) segment, which booked roughly $2 billion of JASSM‑LRASM orders .  Net earnings rose 14 % to $7.28 per share and free cash flow was robust .  The company returned $1.5 billion to shareholders via dividends and buybacks and plans >$10 billion of R&D/capex and $18 billion in shareholder returns by 2027 .  Backlog stands at $173 billion, equivalent to over two years of sales .

Catalysts.

• F‑35 program.  Continued Block 4 upgrades and international orders (e.g., Singapore) underpin multi‑year growth.  The Pentagon expects to purchase ~152 jets annually through 2028.
• Hypersonic missiles and deterrence.  LMT’s LRHW and HACM programs benefit from the OBBB’s emphasis on next‑generation weapons.  Collaboration with the U.S. and allied governments on hypersonic interceptors will open new revenue streams.
• Space and classified programs.  The Skunk Works division and classified space systems contribute to earnings but remain under‑disclosed, offering optionality.

Valuation and outlook. 

 LMT trades at 27.39 × trailing earnings and 17.86 × forward earnings .  Its EV/EBITDA of 18.65 and high ROE (73 %) reflect capital efficiency .  Street analysts maintain an average price target around $525 (≈14 % upside).  We expect mid‑single‑digit sales growth, stable double‑digit margins and strong free cash flow.  Risks include reliance on the F‑35 (over 30 % of sales), potential cost overruns on hypersonic programs, and supply‑chain disruptions.

 

Raytheon Technologies / RTX (RTX)

Business overview. 

RTX (rebranded as RTX Corporation) operates through Collins Aerospace (commercial avionics and aftermarket services), Pratt & Whitney (jet engines) and Raytheon (missile defense and sensors).  Its blended portfolio provides exposure to both commercial air travel recovery and defense modernization.

Financial performance and backlog. 

In Q2 2025 sales climbed 9 % to $21.6 billion with adjusted EPS up 11 % to $1.56 .  Backlog surged 15 % to $236 billion, split $144 billion commercial and $92 billion defense .  Collins Aerospace benefitted from record air‑traffic demand and F‑35 and Airbus programs; Pratt & Whitney revenue grew 12 %; the Raytheon segment’s sales increased 8 % due to strong orders for Patriot and SPY‑6 radars .  Aftermarket services now represent ~40 % of revenues, providing high margins .

Catalysts.

• Commercial aerospace rebound.  The International Air Transport Association projects 5.8 % passenger growth in 2025 , benefiting Collins Aerospace and Pratt & Whitney engine spares.
• Missile defense leadership.  Patriot upgrades, SM‑3 interceptors and hypersonic strike programs like HACM and Long‑Range Stand Off missiles should drive steady defense revenue.
• Backlog visibility.  A $236 billion backlog provides multi‑year revenue certainty.  Additionally, the OBBB funds missile defense and ship‑radar programs that align with RTX’s capabilities .

Valuation and outlook. 

RTX trades at 35.92 × trailing earnings and 26.83 × forward earnings .  Its 2024 revenue grew 17 % to $80.74 billion and earnings increased 49 % .  Analysts rate the stock a Buy with an average price target around $162, roughly in line with current prices .  The main risks include engine‑durability issues at Pratt & Whitney (leading to potential recalls), supply‑chain bottlenecks, and any downturn in commercial aviation.

 

Northrop Grumman (NOC)

Business overview. 

 NOC builds stealth bombers (B‑21 Raider), strategic missiles, cyber systems and satellites.  It emphasises mission systems and classified programs, with an increasing share of international sales.

Financial performance and backlog. 

Q2 2025 revenue increased 1 % to $10.4 billion, but operating income jumped 31 %, delivering margins of 13.8 % .  Mission Systems revenue grew 14 %, Defense Systems 7 % and Aeronautics 2 %, while Space Systems fell due to program completion .  The company raised full‑year guidance to $42.05–42.25 billion in sales and $25–25.40 EPS, with free cash flow up to $3.35 billion .  Backlog ended at $89.7 billion, including significant classified awards and F‑35 and MQ‑4C Triton orders .

 

Catalysts.

• B‑21 Raider.  The stealth bomber is expected to enter low‑rate production this year, generating a long‑tail revenue stream as the U.S. Air Force plans at least 100 aircraft.
• Missile defense and nuclear modernization.  Contracts for Ground‑Based Strategic Deterrent (Sentinel) missiles and hypersonic interceptors provide additional growth.
• Classified and international programs.  Growth in cyber, C4ISR and export contracts (18 % of sales) enhances diversification .

Valuation and outlook. 

NOC trades at 21.9 × trailing earnings and 21.6 × forward earnings , with an EV/EBITDA multiple of 15.67 .  Its ROE of 26.5 % and low beta (0.13) suggest a defensive profile .  FullRatio reports trailing twelve‑month EPS of $27.18, up 28 % year over year .  While valuations are reasonable relative to peers, program execution risk (cost overruns on B‑21 and Sentinel) and potential budget constraints could create volatility.

 

General Dynamics (GD)

Business overview.  GD operates four segments: Marine Systems (submarines and surface ships), Aerospace (Gulfstream business jets), Combat Systems (tanks and vehicles) and Technologies (IT services and C4ISR).  The company offers both defense and commercial exposure.

Financial performance and backlog. 

In Q2 2025 revenue grew 8.9 % year‑over‑year to $13 billion, generating EPS of $3.74 .  Operating earnings rose 12.9 %.  Marine Systems revenue jumped 22.2 %, driven by Columbia‑class submarines , while Aerospace increased 4.1 %, Combat Systems 3.5 % and Technologies 5.5 % .  The company reported a record backlog of $103.7 billion and a total estimated contract value of $161.2 billion .  Reuters notes that 2025 revenue is projected at $51.2 billion with operating margins of ≈10 % .

Catalysts.

• Submarine and shipbuilding boom.  The U.S. Navy’s Columbia‑class ballistic‑missile submarine program and Virginia‑class attack submarines underpin Marine Systems growth; a $1.85 billion contract modification for the Columbia program demonstrates strong funding .
• Business‑jet recovery.  Gulfstream G500/G600 demand is improving, and the G800 is expected to enter service soon .
• C4ISR and IT modernization.  The Technologies segment provides secure cloud and 5G solutions for the Pentagon.

 

Valuation and outlook. 

GD trades at 22.18 × trailing earnings and 20.89 × forward earnings ; EV/EBITDA is 16.11 .  The company has lower leverage (Debt‑to‑Equity 0.45) and high ROE (17.9 %) .  Supply‑chain issues in shipbuilding and cancellations of programs like the M10 Booker tank could impact near‑term margins .  Overall, GD provides a balanced mix of defense and aerospace exposure with moderate growth and solid cash generation.

 

Kratos Defense & Security Solutions (KTOS)

Business overview. 

Kratos is a mid‑cap contractor specializing in unmanned aerial systems (UAS), tactical drones, electronic warfare, missile targets and satellite communications.  It focuses on lower‑cost, attritable platforms and leverages agile manufacturing.

Financial performance and backlog. 

In Q2 2025, consolidated revenue was $351.5 million, beating estimates and prompting management to raise full‑year guidance .  The Government Solutions segment’s revenue rose 27.1 % to $278.3 million, offsetting a softer Unmanned Systems segment .  Total backlog stood at $1.414 billion, with a book‑to‑bill ratio of 1.2 over the past 12 months .  Kratos’ bid pipeline is ≈ $13 billion .

Catalysts.

• Drones and autonomy.  Demand for attritable drone swarms, target drones and autonomous truck platooning continues to expand.  New U.S. legislation—the FORGED Act and SPEED Act—aims to accelerate acquisition of drones and high‑speed munitions , which should benefit Kratos.
• Space and communications.  Partnerships with companies like hiSky for satellite IoT and Champion Tire for autonomous trucking highlight diversification into commercial applications .
• International orders.  The company is pursuing programs with allies in Europe and Asia seeking low‑cost drones.

Valuation and outlook. 

The stock price has surged ≈274 % over the past year , leaving Kratos with extremely high valuation metrics: a trailing P/E of ~912 and forward P/E of ~133 .  The company generates minimal profits (TTM EPS of $0.09), resulting in weak ROE (0.88 %) and low margins .  Investors are paying for future growth rather than current earnings.  Supply‑chain challenges, competitive pressure from larger primes and execution risk could cause volatility.  Position sizing should reflect these risks.

 

AeroVironment (AVAV)

Business overview. 

AeroVironment is a small‑cap specialist in tactical uncrewed aerial vehicles (UAVs) and loitering munitions (Switchblade).  The company recently acquired BlueHalo, broadening its capabilities into directed‑energy systems and larger drones.

Financial performance and backlog. 

Fiscal 2025 revenue rose 14 % to $820.6 million, driven by record Q4 sales of $275.1 million .  Bookings reached $1.2 billion, raising the funded backlog to $726.6 million, 82 % higher than a year earlier .  The Loitering Munitions Systems segment grew 87 %, MacCready Works (R&D) 24 %, and Uncrewed Systems 9 %, with adjusted gross margins expanding .  The company expects FY 2026 revenue of $1.9–2.0 billion and EBITDA of $300–320 million .

Catalysts.

• Loitering munitions demand.  Switchblade systems gained prominence in Ukraine, and allied forces are increasing purchases.  Future variants (e.g., Switchblade 600) and integration with manned platforms could drive growth.
• BlueHalo acquisition.  This $2.4 billion deal adds counter‑UAS, directed‑energy and space capabilities, expanding TAM and cross‑selling opportunities.
• International growth.  Orders from European and Asian NATO members reflect broad adoption of small UAS for surveillance and precision strikes.

 

Valuation and outlook. 

AVAV trades at a forward P/E near 71 and PS ratio above 9 .  The company has yet to achieve consistent profitability (loss per share –$1.38 last year ) but expects earnings improvement post‑acquisition.  High valuation multiples suggest investors expect dramatic growth; integration risk and potential funding delays could create volatility.  We recommend cautious exposure.

 

Portfolio Strategy and Recommendations

1. Core holdings in large primes.  Allocate the majority (e.g., 70–80 %) of the defense allocation to LMT, RTX, NOC and GD.  These firms offer resilient cash flows, broad portfolios and solid dividends.  Among them, LMT and NOC provide hypersonic and space exposure; RTX adds commercial aerospace upside; GD supplies marine and business‑jet growth.  Their forward P/E ratios ranging from ~17 to 26 indicate reasonable valuations relative to earnings growth and lower betas.
2. Tactical allocations to innovators.  Reserve 20–30 % for KTOS and AVAV.  These companies operate in high‑growth niches—attritable drones, autonomy, loitering munitions—but exhibit volatile earnings and rich valuations.  Position sizes should reflect this risk, and stop‑loss or hedging strategies may be prudent.  Look for entry points during market corrections to improve risk‑reward profiles.
3. Monitor geopolitical and policy developments.  A prolonged ceasefire or defense‑budget cuts could temper growth expectations, while escalation (e.g., Taiwan Strait or Middle East) may accelerate procurement.  Legislation such as the FORGED Act, SPEED Act and ongoing EU programs (e.g., ReArm Europe) should be tracked, as they directly affect contract flow.
4. Consider ESG dynamics.  The debate over classifying defense spending as ESG‑eligible could influence institutional ownership .  Investors should engage with stakeholders to understand potential restrictions or opportunities as policies evolve.

 

Conclusion

Defense equities remain attractive for long‑term investors given record military spending, technological innovation and geopolitical realities.  A balanced approach—anchoring on large primes while selectively embracing high‑growth innovators—provides diversified exposure to this secular trend.  Fund managers should emphasize due diligence, monitor valuations and macro risks, and adjust positions as budgets and geopolitics evolve.

Disclaimer

The information provided is for educational and informational purposes only and should not be construed as financial, investment, or consultancy advice. We are not financial advisors or consultants. Before making any financial decisions, please consult with a qualified financial professional who can assess your individual circumstances.