The numbers on European defense are almost hard to believe if you weren’t watching them build.
Between 2014 and 2025, Europe and Canada more than doubled their annual defense spending, with a real increase of 106%. In 2025 alone, they invested a total of $574 billion in defense, a real increase of 20% compared to 2024. That’s not a political talking point. That’s a sustained capital deployment cycle unlike anything the continent has seen since the Cold War.
At the 2025 NATO Summit in The Hague, allies committed to investing 5% of GDP annually on defense by 2035. This commitment includes at least 3.5% of GDP for core defense requirements, with an additional 1.5% for broader defense- and security-related investments. The previous benchmark was 2%. That’s not an upgrade. That’s a wholesale redefinition of what European governments consider baseline.
The stocks responded accordingly. In 2025, European defense stocks posted historic gains: Thales rose 69% over the year, Leonardo 93%, Rheinmetall 152%. Annual revenue for Rheinmetall, Leonardo, BAE Systems, Thales, Hensoldt, and Saab rose an average of 57% between 2021 and 2025.
Now comes the harder part of the trade.
This year, the sector’s fortunes have plateaued somewhat, with the Stoxx Europe Aerospace and Defense index down 1.2% year-to-date, compared with a 4.8% return in the broader Stoxx 600 index. Analysts see 2026 as a period of consolidation for the sector, in which bullishness over Europe’s increased defense spending is replaced by greater scrutiny of individual companies’ performance and fundamentals.
Sentiment weakened further in the spring after a set of underwhelming first-quarter earnings reports. Missed earnings estimates from industry bellwether Rheinmetall led investors to start questioning the potential for further upside in the sector, amid lofty valuations.
What’s interesting is how this splits apart when you look company by company rather than treating the sector as one trade.
A runaway rally in European defense stocks has hit a wall on concern that profits aren’t rising fast enough to justify valuations that are now richer than technology. Rheinmetall has dropped around 20% since peaking last year, and a broader index has largely flatlined since mid-January in its weakest start to a year since 2021.
Rheinmetall is still the growth story — the company expected sales to grow between 40% and 45% in 2026 — but its 400% gain over the past 3 years, and 150% gain across 2025, is an example of investor sentiment pricing for years of sustained growth. When shares are trading on such high multiples and such high growth is already baked in, it’s hard to work out exactly the right multiple to value Rheinmetall.
Leonardo is a different story. Barclays analysts upgraded their recommendation on Leonardo to Overweight, saying the company has greater earnings momentum relative to peers. Its diversified portfolio and low exposure to Ukraine also offer resilience to potential impact from a ceasefire. Leonardo disclosed plans to double profits by 2030.
Thales may be the most quietly interesting name of the three. A remarkable fundamental turnaround — earnings per share surged 61.8% on a trailing basis. The P/E has fallen to 29.61, making Thales the valuation champion of the trio. FCF yield of 5.16%, the highest of the three. ROE of 21.63%. It also happens to have the most diversified revenue base, with meaningful exposure to cybersecurity and space.
The structural argument for the whole sector is intact. Accounting for fiscal capacity, this could lift European defense spending toward €800 billion by the end of the decade. The order backlogs of all three major companies are at record highs, securing future revenues regardless of short-term developments.
But here’s the part the market is slowly learning: even though investment has increased sharply, total equipment stocks in European NATO countries remain below their 2021 levels, reflecting military donations to Ukraine, the retirement of legacy systems, and long delivery timelines for new equipment. Spending doesn’t equal delivery. And delivery timelines — not commitments — determine when earnings actually flow through.
Future growth will come from drones, AI-enabled systems, cyberdefense, and missile defense. Firms leading in these areas, such as Thales and Saab, may see outsized growth. The companies best positioned are not necessarily the ones with the largest headline revenue gains right now.
The defense supercycle is real. The decade-long spending runway is real. The question investors are now asking — finally — is whether the price already assumes perfection. Some of these names do. Others, not yet.
