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Defence companies have been among the best stocks to buy in recent years. Today, governments across Europe are boosting their military budgets in a deteriorating security landscape.
Many firms in the sector now have much higher valuations, posing risks to the rally’s momentum. But military investment’s a long-term endeavour. There are good reasons to believe defence stocks are still only partway through a multi-year growth cycle.
Here are some shares in the industry worth looking at.
Buying defence shares
Arms manufacturers are controversial investments. Many leading pension providers shun them on ethical grounds. Some readers will understandably share these concerns.
But the political climate’s changing. The Treasury’s developing plans for greater transparency in ESG policies, hoping to spur more institutional investment in defence.
It seems the plan’s already working. Recently, Aviva expressed its “appetite to invest more” than the £900m it allocates to UK defence stocks. This might be the tip of the iceberg.
The possibility of large capital inflows from City institutions could provide extra fuel to sustain defence firms’ outperformance in months and years to come.
Heavy hitters
Four aerospace and defence companies feature in the FTSE 100 index. It’s worth putting some high up on a list of stocks to consider buying.
Only one’s a pure defence play. BAE Systems is Europe’s largest military contractor. From fighter jets to missile launchers to surveillance systems, the business covers the full gamut of military products.
With a key role in the AUKUS security partnership, a £77.8bn order backlog, and a history of dividend growth stretching back decades, there’s plenty for investors to love about this company. However, BAE’s exposure to US government contracts is a risk given anticipated Pentagon budget cuts.
Babcock International, Melrose Industries, and Rolls-Royce also have a significant defence offering, alongside business interests in the civilian world. For the latter two, civil aerospace is a more important revenue source, giving additional diversification. However, they may not be suitable for investors seeking unalloyed defence stocks to buy.
By contrast, Babcock is over 74% defence-focused. This business, which maintains Britain’s nuclear submarines, has less American exposure than BAE Systems. Nonetheless, it’s still vulnerable to supply chain risks from President Trump’s tariffs.
An under-the-radar stock
Beyond the FTSE 100, specialist defence technology business Chemring Group (LSE:CHG) also deserves consideration. This FTSE 250 stock has nearly doubled over five years.
One thing I like about Chemring shares is the company’s exposure to the space sector. NASA and SpaceX are key customers for the firm’s energetics products.
US plans for a space-based ‘Golden Dome’ missile defence shield show the increased importance of the final frontier for military operations. Reagan’s abandoned ‘Star Wars’ initiative from the 1980s may soon become a reality, and Chemring could stand to benefit.
I also admire the group’s ambition. A 67% increase in the capital investment programme to £200m will underpin efforts to almost double annual revenues to £1bn by 2030.
However, slimmer FY24 profit margins due to operational difficulties at its US countermeasures factory could hurt the Chemring share price if problems persist. Margins slumped to 13.9% from 14.6% the year before.
Then again, with further growth opportunities in cybersecurity and artificial intelligence, I believe this defence stock merits a close look.
