Sir Keir Starmer during a visit to Operation Interflux near Salisbury, Wiltshire. Credit: Stefan Rousseau, PA Archive
When football club Borussia Dortmund announced that Rheinmetall, a German weapons manufacturer, would become their stadium sponsor in May 2024, the move was widely condemned by the football world. Fans of the club have made their displeasure with the action known, frequently protesting with banners, chants and members’ votes.
But when the world changes quickly, so too do reputational impediments. In the right conditions, those who have made their fortunes selling tanks and guns can reposition themselves as peace merchants.
Distaste for defence firms has extended to stockpickers, with a preference for environmental, social and governance (ESG) investing prevailing in recent years. But with President Trump demanding that European countries raise defence spending to 5pc of their GDP – and hinting at a future which could see his country take a backseat in the protection of our continent – attitudes are changing.
Michael Hewson, of trading platform CMC Markets, says: “The penny finally appears to have dropped that while the label ‘ethical investing’ sounds nice and cuddly and makes some investors feel good about themselves, the cold, hard facts remain that a strong military capability is the best defence when it comes to deterring hostile actors.
“Given the continued uncertain geopolitical climate – the Russian invasion of Ukraine, China’s ambitions towards Taiwan, the instability in the Middle East – the areas of defence, as well as internal and external security, are only likely to become more important as the decade goes on.”
A number of key European defence stocks have benefited from a surge in their share prices in response to the Continent’s renewed focus on security. Among the pack’s leaders year-to-date are Dortmund sponsor Rheinmetall (60pc), Italy’s Leonardo (43pc), France’s Thales (39pc) and Sweden’s Saab (29pc). Rolls-Royce, a leading engine manufacturer for military vehicles, has also enjoyed a 6pc rise since the year began.
Thus far, an obvious choice for stockpickers has been BAE Systems, formerly British Aerospace Engineering, which has risen 18pc so far this year and is Europe’s largest defence contractor – with a strong presence in the US to boot. However, it has already seen its share price double since early 2022 and value investors may wish to look towards lesser-known stocks, Mr Hewson argues.
“Babcock International has expertise in nuclear, aviation and land, in both civil as well as military, providing maintenance services for the UK’s nuclear submarine fleet, as well as the surface fleet at Clyde and Devonport shipyards. The company also provides support to the RAF through its Hades programme, which includes aircraft maintenance, general engineering and training support at 16 RAF stations across the UK.
“QinetiQ is a lesser-known but no less important part of the defence landscape for the UK as well as US military. The company is an expert in the field of unmanned air, land and sea reconnaissance services and drones. They are also helping to develop weapons systems like the new DragonFire laser, which the Royal Navy hopes to use on its ships from 2027 to shoot down drones and missiles.
“Chemring is another important UK engineering company, providing services to the aerospace, defence and security market and whose key strength is in designing sensors and detection, as well as countermeasures (chaff) to protect aircraft and ships from missiles.”
Chemring is being eyed up by private equity, with American firm Bain Capital reportedly tabling a $1.4bn (£1.1bn) bid for the manufacturer on Monday, causing its shares to spike.
But should the sector’s strong start to the year ward off investors hoping to see further gains?
Russ Mould, investment director at AJ Bell and regular Questor columnist, says: “There are three avenues of potential revenue open to defence contractors. First, there is equipment for sale domestically and to European partners. Second, there are service and maintenance revenues from kit already sold and then kit that will be sold.
“Finally, there is scope to sell worldwide. The US and Russia are tussling to sell F-35s to India, and Europe does not seem to be getting a look in there. But BAE Systems is a major player in the US and is already raking in orders via the Australia-UK-US defence partnership, notably via the sale of nuclear submarines and Hunter frigates to Australia.”
There is no shortage of demand for BAE Systems’ services, with the firm enjoying a record order backlog of almost £78bn, three times its 2024 sales figures, which stood at £28.3bn. For 2025, this figure is forecast to rise to £30bn.
Mr Mould adds: “That sort of visibility may appeal to investors, during these uncertain times, whether the shares have already done well or not. But BAE’s shares now trade at nearly 19 times forward earnings for 2025. That is a premium of more than 30pc to the FTSE 100, so investors are having to pay up for the backlog and visibility of earnings.
“As such, the easy money may have been made by those who bought when ESG investing meant BAE was beyond the pale for many, but the manner in which share price gains and British and European strategic announcements may flush out a bid for Chemring suggests there could still be opportunities for investors to research.”
Despite entrenched ESG trends, there are funds on offer for investors seeking exposure to defence stocks, says Darius McDermott, managing director of fund research firm FundCalibre.
“While many funds tend to avoid defence stocks due to ESG criteria, The City of London Investment Trust holds BAE Systems as one of their largest stocks. Investors who want a purer play on defence may wish to consider HANetf’s Future of Defence fund, which combines traditional defence names with cyber security stocks as well.”
