What’s next for defense stocks after the military spending boom?

European defense stocks rose in 2025, driven by a sharp increase in government military spending targets in response to growing geopolitical instability.

However, this year the sector’s luck has stabilized somewhat. Stoxx Europe Aerospace and Defense The index is down 1.2% year-to-date compared to a 4.8% return on the broader Stoxx 600 index.

But analysts see 2026 as a period of consolidation for the sector, where the rally towards increased European defense spending is replaced by greater scrutiny of the performance and fundamentals of individual companies.

“Investors are becoming very picky and selective,” said Morningstar stock analyst Loredana Muharremi.

“What investors want to see right now is earnings and cash flows, and we believe we’ll see some upside towards the second half of the year when orders come in, down payments from governments come in and deliveries come in – but it will certainly take some time for stock prices to get back to where they were.”

Shares of defense companies initially performed well after the United States and Israel launched an attack on Iran on February 28, as concerns emerged that the conflict would escalate into an all-out war that would span the entire Middle East region.

But since then, the gains of the industry’s biggest names have tapered off. Tools like this WisdomTree European Defense ETF And iShares European Defense ETFand also more spherically inclined VanEck Defense ETFall below pre-war levels.

Confidence weakened further in the spring after a series of lackluster first-quarter earnings reports. Missed earnings forecasts from industry leaders Rheinmetall It has led investors to begin questioning the potential for further upside in the sector amid high valuations.

RheinmetallThe eye-popping 400% gain over the past 3 years and the 150% gain in 2025 is an example of investor sentiment pricing for sustainable growth for many years to come.

“It’s hard to find exactly the right multiple to value Rheinmetall when shares are trading at such high multiples and such high growth has already occurred,” Quilter Cheviot equity research analyst Matthew Dorset told CNBC over the phone.

Dorset also sees the potential for companies to struggle to adapt to the dynamic nature of warfare and changing equipment needs as a factor that could hinder the industry in the future.

“What products will be used in five or ten years?” he added.

“One of the lessons from Ukraine is that this is clearly a UAV and Counter-UAV war, a fairly static war. Do we really need that many ground vehicles, tanks and artillery?”

Morningstar’s Muharremi said companies with more diversity in their product offerings, especially those with strong electronic components, will fare better than companies that are predominantly land-based.

Other headwinds may come from the broader geopolitical environment, albeit on a smaller scale. European defense stocks The rise occurred on Thursday and Friday after the Ukrainian parliament approved a 90 billion euro ($104.6 billion) loan agreement with the EU.