The defence sector is flying, which is great news for BAE Systems (LSE: BA) shares. The same goes for other FTSE 100 stocks with defence exposure, notably Babcock International Group (LSE: BAB) and Rolls-Royce Holdings (LSE: RR).
BAE Systems and Rolls-Royce will be fixtures in many Stocks and Shares ISA and SIPP portfolios, but investors may have mixed feelings about their success. It reflects the dangerous world we live in.
Weapons-grade growth stocks
Russia’s invasion of Ukraine in 2022 lit a fire under the sector and the flames keep being fanned. US intervention in Venezuela, the furore over Greenland, and turmoil in Iran have all driven these stocks in 2026.
On 22 January, BAE Systems revealed it had been contracted to upgrade radar systems on Typhoon fighter jets, alongside Italy’s Leonardo, as part of a £453m UK government investment to counter the drone threat. BAE will be hoping other Typhoon operators follow suit. It already boasts a bumper £78.3bn order book, while smaller but fast-growing Babcock has nearly £10bn of orders.
UK-listed defence stocks got another potential boost earlier this month when Donald Trump announced plans to restrict dividends and share buybacks for US defence contractors unless they accelerate weapons production. That could squeeze shareholder returns stateside, something FTSE 100 firms don’t face.
Trump also wants the US to ramp up defence spending, which should benefit BAE Systems, as 44% of its earnings come from America. European governments have talked tough, but haven’t always backed words with cash.
The UN nonetheless estimates global defence budgets could rise to $3.9trn by 2035, a 244% increase on 2024. Unless there’s a sudden rush to détente, this looks set to continue.
Valuations worry me though. BAE’s price-to-earnings ratio has climbed to 28.8, while Babcock’s is similar at 28.9. Rolls-Royce looks pricier still, with a P/E above 60, although it has its fingers in far more pies than defence.
Top FTSE 100 defensives
Defence shares keep climbing. BAE is up an impressive 15.4% in the last month, turning £10,000 into £11,540. Over a year, it’s up 60%, lifting £10k to £16,000, plus dividends.
Babcock has risen a surprisingly 15.7% in the last month, turning £10k into £11,570. The fact that BAE and Babcock have such similar recent growth profiles and P/Es suggest they’re now being driven by broader issues rather than individual company news. Babcock has done much better over 12 months though. It’s surged 180%, transforming £10k into £28,000 (again before dividends). Investors are making serious money here.
Both stocks have slipped back in recent days, which shows how toppy the sector feels. It needs a steady flow of bad news (of the geopolitical variety) to keep flying. Rolls-Royce has lagged so far this year, rising a modest 6.5% turning £10k into £10,650. However, it’s still up 104% over the year.
Even in a booming sector there are risks. Supply chain issues, technical problems, order bumpiness, world peace. Those who don’t have any exposure to the sector might want to consider building it today, but at these prices they should approach with caution.
