MarketScreener
Over five years, the chart above tells a counter-intuitive story: the MSCI Europe Aero & Defense has surged by nearly 250%, while the US S&P Aerospace & Defense Select Industry Index has posted gains roughly half as large. Yet behind this enthusiasm lie two beliefs. The first: a conflict generates additional orders that benefit manufacturers. The second: war raises geopolitical risk, prompting governments to increase military budgets. The logic is not wrong, but it runs up against the sector's operational and accounting reality.
The misunderstanding about the value chain
Major defence prime contractors build most of their profitability on multi-year programmes negotiated well before hostilities break out. When a conflict starts, most big contractors' order books are often already filled for several years. Lockheed Martin is the most recent illustration: at the end of 2025, its backlog - that is, orders already signed but not yet delivered - hit a record $194bn, representing more than two-and-a-half years of revenue.
What is depleted first on the battlefield is short-range ammunition (artillery, anti-tank weapons) in wars of attrition such as in Ukraine, and medium-range air-defence interceptors for crises in the Middle East - a segment that, at Lockheed Martin, accounts for less than 20% of revenue across all ranges. The share of strictly emergency replenishment munitions is assumed to be far smaller. And even for that segment, ramping up output requires heavy investment and supply chains that cannot adjust overnight, according to a US Congressional adviser interviewed in early March 2026.
The situation at the start of this year illustrates it well. The massive use of attack drones costing $35,000 a unit forces allies to burn through Patriot interceptors or SM-3 missiles billed at up to $11m each. Replenishment is generating record revenue, but at lower profitability: the Pentagon is now imposing "open-book" contracts on emergency orders for 2026. This mechanism, governed by the Truth in Negotiations Act (TINA) and the presidential decree of 7 January 2026, requires contractors to provide full access to their certified cost data (Certified Cost or Pricing Data). By favouring Cost-Plus-Fixed-Fee structures (FAR 16.306), the state reimburses all industrial costs but locks the profit fee in absolute terms, effectively capping net margins to avoid any suspicion of excessive war profiteering. An average around 10% is the norm for major industrial prime contractors (including the 9.07% net margin posted by Thales in 2025). While exceptions such as Dassault Aviation show slightly higher margins, they do not escape industrial reality: they are hit by soaring steel and energy costs which, passed through the production chain, now cap their net profitability.
The European premium, a riskier bet than it looks
If the regulatory framework is dictated by Washington, the sharpest asymmetry is in Europe. While the Old Continent accounts for 33% of global arms imports over 2021-2025, according to SIPRI (Stockholm International Peace Research Institute), its own champions, such as BAE Systems or Leonardo, are pursuing a "Trojan horse" strategy. By buying US assets (Ball Aerospace, DRS), they are trying to capture a share of the future US defence budget of $1.5 trillion promised for 2027. This double exposure (geographic and budgetary) helps explain why European investors accept multiples of 32x earnings, supported by book-to-bill ratios above 1.2x, according to Bank of America. Yet this "European premium" is risky: unlike the United States, the continent's industrial players face more volatile cost inflation (notably high energy prices, operating costs to transform assets, and capital costs linked to permitting delays), which could crush net margins.
When the state takes back control
This is the most structural risk - and the least discussed. The US sector's historic outperformance has rested not on organic margin growth, but on massive share buybacks. Lockheed Martin cut its share count by 25% in 10 years to boost earnings per share. That lever disappears in January 2026: a presidential decree banned major contractors from conducting buybacks or paying dividends whenever the state finances their production lines. If taxpayers pay for factories, that money must not flow to shareholders. In parallel, Congress is debating raising the buyback tax from 1% to 4%.
This mechanism has precedents. During the Second World War, Washington renegotiated downward contracts already signed with arms makers, a practice repeated during the Korean and Vietnam wars. The state, the sector's sole customer, always reasserts control over value creation in times of crisis.
Behind the share-price rally, a trap for shareholders
Global arms transfers rose by 10% between 2021 and 2025, according to SIPRI's report of 9 March 2026, driven by a Europe that now represents 33% of global imports. War boosts revenue and politically legitimises military budgets. But it compresses margins, caps shareholder returns and exposes the sector to growing state intervention.
Defence stocks are gradually turning into a sovereign "utility": a guaranteed business, but one whose profitability is constrained by the public interest. Value migrates towards players that escape price controls on physical hardware: software architects such as Palantir, whose Pentagon data-analysis contracts are not subject to any regulatory margin cap, or combat-AI developers such as Saab, whose defence electronics division draws its value precisely from the intangible. If shareholders benefit in the short term from the mechanical rise in prices, as with Lockheed Martin (+45% in six months), that latent gain rests on an expansion in valuation multiples (P/E) rather than an explosion in actual profits.
