European defence stocks are booming so what has the FTSE 100 got to offer?
Since September 2020, there are nine companies on the FTSE 100 that have seen their share prices rise by more than 300%. Of these, three have exposure to the military sector.
And itâs not just in the UK where increased defence spending is helping boost share prices of the industry’s contractors. The STOXX Europe Total Market Aerospace & Defense index has returned 318% over the same period. For comparison, European stocks as a whole have delivered a 50% increase.
Although I acknowledge that investing in the sector isnât to everyoneâs liking, I believe itâs the primary duty of a government to protect its people. And given the share price movements of the UKâs three biggest listed suppliers in the sector, others appear to agree with me.
Letâs take a closer look.
A finger in many pies
In 2024, Rolls-Royce Holdings generated 25% of its revenue and 26% of its underlying operating profit from its defence division.
And although this part of the business is performing well, I think itâs the post-pandemic recovery in air travel that has been the primary reason for the groupâs share price increasing by more than 2,000% over the past five years.
An industry specialist
But there are two other FTSE 100 members that are pure defence stocks.
Controversially, the BAE Systems (LSE:BA.) share price has benefitted most from the tragic war in Ukraine. Like others in the industry, the majority of its revenue is earned from multi-year contracts. At 30 June, the group reported an order backlog of £75.4bn â roughly three times its annual sales.
Itâs the biggest supplier to the Ministry of Defence so it should benefit from the governmentâs commitment to spend 2.5% of GDP on the UKâs army, navy and air force from April 2027.
However, the groupâs stock isnât cheap. Analysts are expecting earnings per share (EPS) in 2025 of 75p. If correct, this implies a forward price-to-earnings (P/E) ratio of 26.9. This is well above the Footsie average. And with a yield of 1.7%, there are better income opportunities elsewhere.
But I think itâs operating in the right sector at the right time so I believe it’s a stock worthy of further consideration.
Another alternative
The other FTSE 100 defence company is Babcock International Group (LSE:BAB), having joined the index in March.
Last week (25 September), it gave a trading update ahead of its annual general meeting. Not surprisingly, it described the current macro environment as âsupportiveâ.
Again, its shares are expensive. The stock has a forward (2025) P/E ratio of 24.9. But Europe-wide, the industry is trading at 31.6 times future earnings. So perhaps it’s not as unreasonable as it initially appears.
However, at 0.5%, its yield is even lower than that of BAE Systems.
Another concern I have is that the group has incurred significant losses on one of its contracts with the Royal Navy. Hopefully, lessons have been learned.
But it has a large (and growing) order book. And it says itâs on track (over the medium term) to raise its underlying operating profit margin from the 5.4% it achieved in its 2025 financial year to âat least 9%â. Analysts are expecting EPS to increase by 33% over the next three years.
For these reasons, I think itâs a stock that long-term investors could consider.
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James Beard has positions in Babcock International Group Plc and Rolls-Royce Plc. The Motley Fool UK has recommended BAE Systems and Rolls-Royce Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
