What’s next for defense stocks after the military spending boom?

European defense stocks had a bumper year in 2025, driven by sharp increases in national military spending targets in response to increasing geopolitical instability.

However, the sector’s fortunes have plateaued somewhat this year. Stoxx Europe Aerospace and Defense The Stoxx 600 index has returned 4.8% year-to-date, compared with a year-to-date decline of 1.2%.

But analysts see 2026 as a period of realignment for the sector, with bullish stances on increased European defense spending giving way to greater scrutiny of individual company performance and fundamentals.

“Investors are becoming very picky and selective,” Morningstar equity analyst Loredana Muharemi said.

“What investors want to see now is earnings and cash flow, and while we believe there will be some upside towards the second half of this year as orders come in, down payments are received from the government, and deliveries are made, it will definitely take some time for the stock price to return to its previous level.”

Shares of defense companies initially held firm after the United States and Israel launched attacks on Iran on February 28, raising concerns that the conflict could escalate into a full-scale war involving the entire Middle East region.

But since then, profits for the industry’s biggest companies have been subdued. vehicles such as WisdomTree Europe Defense ETF and iShares Europe Defense ETFas well as more globally oriented ones. Van Eck Defense ETFall of which are below pre-war levels.

Sentiment worsened further in the spring following a series of weak first-quarter results. Revenue forecasts by industry leaders are off. line metal This has led investors to question the sector’s potential for further gains amid soaring valuations.

line metal‘s impressive 400% rise over the past three years, and 150% rise for all of 2025, is an example of how investor sentiment is pricing in sustained growth in the coming years.

“It’s hard to pinpoint the right multiple to value Rheinmetall when the stock is trading at such a high multiple and has such high growth already built in,” Matthew Dorsett, equity research analyst at Quilter Cheviot, told CNBC by phone.

Dorsett also sees the potential for companies to struggle to adapt to the dynamic nature of warfare and changing equipment needs as factors that could hold the industry back in the future.

“Which products will be used in five years, 10 years?” he added.

“One of the lessons from Ukraine is that this is clearly a drone and anti-drone war, a very static war. Do we really need that many ground vehicles, tanks and artillery?”

Morningstar’s Muharemi said companies that are more diversified in their product offerings, especially those with strong electronic component suites, will fare better than those that are primarily land-based.

Further tailwinds, albeit small in scale, are likely to come from the broader geopolitical environment. European defense stocks rose on Thursday and Friday after Ukraine’s parliament ratified a 90 billion euro ($104.6 billion) loan deal with the European Union.

Reuters reported on Thursday, citing anonymous sources, that Zelensky and Swedish Prime Minister Ulf Kristersson would jointly announce an agreement to provide Gripen fighter jets to Ukraine.

The pair signed a letter of intent in October last year under which Sweden would sell up to 150 Saab Gripen fighter jets to Ukraine.

Saab topped the Stoxx 600, with the Swedish fighter jet maker ending the day up 7.4%.

German tank parts maker Lenk rose 5.4%, while France’s Exail Technologies and Germany’s Rheinmetall soared 13.2% and 4.2%, respectively.