Al Root

Warfighting and war policies are changing, creating some uncertainty for investors.

Barron's believes defense contractors will adapt to changing times and changing technologies. They typically do. We recently wrote positively about Northrop Grumman, L3Harris Technologies, Booz Allen Hamilton, and small-capitalization company AeroVironment.

However, there are other stocks for investors to consider, including European players.

Lower-cost electronics and artificial intelligence are changing how wars are fought and how war machines are built and upgraded. To understand the shift, look no further than Palantir Technologies stock's valuation. The AI leader trades for almost 200 times 2025 estimated earnings. It's valued at almost $275 billion, more than Lockheed Martin, Northrop Grumman, and General Dynamics combined.

Time will tell if Palantir is at the "right" valuation, but aerospace and defense investors used to dealing with S&P 500-like price-to-earnings ratios don't have to go full-Palantir to get exposure to emerging defense trends.

Barron's wrote positively about smart weapons maker AeroVironment, believing its merger with BlueHalo could unlock value. Kratos Defense & Security Solutions and Karman Holdings are two other small-cap companies working to fuse AI and unmanned vehicles and weaponry.

"Karman is uniquely positioned in the defense supply chain, seated between the prime original equipment contractors...and the traditional supply base for the three segments which it serves," says Citi analyst Jason Gursky. Those segments are hypersonic propulsion, space launch, and missile defense.

Karman stock trades for about 96 times estimated 2025 earnings, but earnings are expected to grow by 33% a year on average for the coming three years. Gursky rates shares Buy and has a $42 price target for the stock, up 10% from recent levels.

All five analysts covering the stock rate shares Buy. The average Buy-rating ratio for stocks in the S&P 500 is about 55%. The average analyst price target for Karman stock is about $41.

Kratos is popular on Wall Street, too, with 69% of analysts covering the company rating shares at Buy. The average price target is about $37, valuing the company at about 70 times estimated 2025 earnings. Kratos is expected to grow earnings at about 35% a year on average for the next three years.

Investors shouldn't forget what's happening overseas, either. Europe spends about $350 billion annually on national defense, or about 2% of gross domestic product. That ratio is going up, sending the stock of European defense contractors higher.

Shares of Germany's Rheinmetall, Italy's Leonardo, U.K.'s BAE Systems, France's Dassault Aviation and Thales, and Sweden's Saab are up an average of 109% since the Nov. 5 U.S. presidential election. Gains have left the six stocks trading for an average of 32 times estimated 2025 earnings, up from about 20 times a year ago.

That doesn't mean there are no good values, though.

"You're looking at growth that's completely unprecedented since the 1930s," says Vertical Research Partners analyst Rob Stallard. Years down the road, investors will look back at 2025 as a buying opportunity.

Stallard prefers BAE Systems, the U.K.-based diversified supplier of technology for jets, missiles, ships, and submarines. Shares trade for about 22 times estimated 2025 earnings. That's not an eye-popping multiple, but it's up from a 14 times multiple in recent years.

Earnings are expected to grow about 10% a year for the coming few years. Of course, if Stallard is right, that growth estimate will prove to be low. He rates shares Buy and has a 1,830 pence price target for shares, up about 8% from recent levels.

About 53% of analysts covering BAE stock rate shares Buy. The average price target is about 1,740 pence.

The average Buy-rating ratio for these six European companies is about 55%. The most popular stock is Rheinmetall with 89% of analysts rating shares Buy. The average price target, however, is about EUR1,650, below a recent price of EUR1,694.

Rheinmetall shares have jumped some 250% since the election. Wall Street has had trouble keeping up.

Write to Al Root at allen.root@dowjones.com

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May 10, 2025 03:00 ET (07:00 GMT)

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