Europe is undergoing its most significant defense build-up since the Cold War. Three forces are driving this shift: Russia’s invasion of Ukraine shattered three decades of calm and exposed the extent to which European stockpiles and industrial capacity has depleted; Washington’s push for allies to shoulder more of NATO’s cost has ended the assumption that America will automatically backfill any shortfall; and rising cyberattacks and sabotage of critical infrastructure have made rearmament a domestic priority, not just an alliance one. Together, these forces have transformed defense from a fiscally constrained, politically sensitive line item into a structural, multi-decade spending priority.
The scale of the response is unprecedented in recent history. European defense spending declined from over 3% of GDP in the 1980s to a trough of roughly 1.4% in 2014, stagnated near that floor for a decade, and has since jumped to 2.3% in 2025, with NATO members now committed to 3.5-5% by 2035, the sharpest reversal in the region’s defense burden in more than 30 years.
For equity markets, the consequences have been dramatic: European defense contractors have re-rated sharply, order backlogs have reached record highs, and a sector once considered defensive and slow-growing has become one of the continent's most closely watched growth trades.
The spending commitment is settled but a government spending pledge is a promise, not a payment. The open question is whether Europe’s primes can convert a record order book into delivered earnings and Rheinmetall’s 2026 has already shown how that debate cuts.
A Structural Shift in European Defense Spending
Europe’s defense budgets have moved from cyclical to structural. At the NATO summit in The Hague in June 2025, allies committed to invest 5% of GDP annually on defense- and security-related spending by 2035 replacing the previous 2% benchmark set at the 2014 Wales Summit that took a decade to achieve. The commitment is split into two categories: at least 3.5% of GDP for core defense requirements, and up to 1.5% for related areas such as critical-infrastructure protection, cyber resilience, and strengthening the defense industrial base. The trajectory is to be reviewed in 2029, and all 32 members endorsed the target except Spain, which secured an exemption at ~2.1 percent of GDP.
The financial momentum is already visible. According to NATO, European allies and Canada increased their combined defense expenditure by nearly 20% in real terms in 2025 vs 2024, an increase of more than USD 90 billion (in 2021 prices). Collective spending has climbed from 1.4% of combined GDP in 2014 to 2.3% in 2025. NATO's 2026 estimates show 5 allies meeting the 3.5% core defense guideline and 5 meeting the full 5% commitment while 17 clear the softer 1.5% defense- and security-related threshold.
At the EU level, the European Commission's ReArm Europe / Readiness 2030 plan, unveiled by President Ursula von der Leyen in March 2025, aims to mobilize up to €800 billion in defense-related spending through 2029. That includes €150 billion in EU-backed loans through the new Security Action for Europe (SAFE) instrument, plus activation of the Stability and Growth Pact's national escape clause allowing member states to raise defense spending by up to 1.5% of GDP annually for 4 years, through 2028, without breaching EU fiscal rules, an option 16 member states requested within weeks of the plan’s launch.
Taken together, these commitments signal something new for investors: not a one-off spending spike tied to a single conflict, but a sustained, treaty-backed re-armament cycle with a decade-long horizon and broad political consensus, the kind of demand visibility that fundamentally changes how the sector is valued.
Source: Nato, Evalueserve analysis
Europe is undergoing its most significant defense build-up since the Cold War. Three forces are driving this shift: Russia’s invasion of Ukraine shattered three decades of calm and exposed the extent to which European stockpiles and industrial capacity has depleted; Washington’s push for allies to shoulder more of NATO’s cost has ended the assumption that America will automatically backfill any shortfall; and rising cyberattacks and sabotage of critical infrastructure have made rearmament a domestic priority, not just an alliance one. Together, these forces have transformed defense from a fiscally constrained, politically sensitive line item into a structural, multi-decade spending priority.
The scale of the response is unprecedented in recent history. European defense spending declined from over 3% of GDP in the 1980s to a trough of roughly 1.4% in 2014, stagnated near that floor for a decade, and has since jumped to 2.3% in 2025, with NATO members now committed to 3.5-5% by 2035, the sharpest reversal in the region’s defense burden in more than 30 years.
For equity markets, the consequences have been dramatic: European defense contractors have re-rated sharply, order backlogs have reached record highs, and a sector once considered defensive and slow-growing has become one of the continent's most closely watched growth trades.
The spending commitment is settled but a government spending pledge is a promise, not a payment. The open question is whether Europe’s primes can convert a record order book into delivered earnings and Rheinmetall’s 2026 has already shown how that debate cuts.
The Equity-Market Response: From re-rating to reality check
Budgets translated into equities faster than they translated into hardware. Across FY2025, every major European prime posted record orders, expanding margins and an order book that stretches years beyond current output. 2025 full-year results underscore how rising budgets are translating into financial performance.
Source: Nato, Evalueserve analysis
The common thread is visibility, not just growth. Backlog now covers multiple years of output at every prime, and Thales quantified its defense book at roughly 3.4 years of defense segment sales. Rheinmetall is the extreme case at over six times annual revenue, which is precisely why it re-rated hardest and why it is now the sector’s stress test.
Rheinmetall’s own 2026 makes the point. H1 sales rose 39% to €5.2bn with margin of 15.0%, backlog reached €80.5bn (+44%, 70% fixed orders) and the shares still de-rated sharply from their 2025 peak. Two disclosures explain why: operating free cash flow was negative €1.6bn as inventory was built ahead of deliveries, and full-year sales guidance was trimmed to €13.7–14.2bn (previously €14.0–14.5bn) after the cancellation of F126 frigate programme, a reminder that government procurement remains political, unpredictable, and subject to shifting military priorities, however strong the underlying demand. A government spending pledge is a promise, not a payment. It has to move through parliaments, ministries and multi-year procurement contracts before it becomes revenue.
The share-price story of Rheinmetall has been extraordinary. Over the five years to early October 2026, Rheinmetall's stock rose more than 1,000% from around €80 to €939.1, making it one of Europe's best-performing large-caps and a symbol of the defense trade. Importantly, the story is not without volatility: after peaking near €2,000, the shares corrected meaningfully through 2026 (trading around €930–960 in early October 2026), a reminder that expectations have run high and that execution now matters as much as demand.
Valuation: where the premium sits. The re-rating was earned first and questioned later. In 2025 Rheinmetall rose 155%, Leonardo 92% and Thales 68%. In 2026 the trade has reversed: the STOXX Europe Total Market Aerospace & Defense index is flat year-to-date, and Rheinmetall down roughly 39% and Leonardo and Thales down ~4%, even as BAE Systems is up around 12%. A single theme has become a stock-picker’s market. Rheinmetall’s premium looks modest on enterprise value but clear on earnings. Its 2025 EV/EBITDA of 19.3x sits only modestly above the European peers at 16.7x, while trailing P/E of roughly 35x a clear premium to the STOXX Europe Total Market Aerospace & Defense at 25.7x. On consensus FY27 earnings, the P/E falls to 19x*, but only if earnings grow roughly 50% next year as consensus expects. That is why cash flow and guidance now move the stock more than order intake.
* Rheinmetall forward P/E calculated by Evalueserve on company-hosted analyst consensus (24 Aug 2026)
The read-across is visible in the sector. European defense has underperformed the wider market year-to-date, with sentiment souring as investors weigh the prospect of an end to the wars in Ukraine and the Middle East, and question how much of governments’ military spending commitments will materialize.
The cycle has moved past the phase where a bigger order book is automatically a better share price. Backlog is now the input; conversion, cash and margin are the scorecard.
What we are watching
- Cash conversion, not order intake. Negative operating free cash flow across the ramp is the sector’s defining near-term metric.
- Budget-to-contract lag. Pledges convert to revenue only through signed, funded procurement — and Spain’s exemption shows commitments can bend.
- Capacity and supply chain. Skilled labour, energetics and munitions throughput remain the binding constraints on delivery.
- Execution risk from M&A. Rheinmetall’s naval integration and Leonardo’s Iveco Defense deal add complexity mid-ramp.
- Backlog, order intake and “nomination” are defined differently by each issuer; cross-company multiples need normalising before they mean anything.
How Evalueserve helps
Capital is following the rearmament theme, but more selectively than a year ago. European investors can now choose from 19 defense ETFs, most launched in 2025, according to Morningstar. The largest, the WisdomTree Europe Defense UCITS ETF, has grown to about US$4.8 billion in assets since its March 2025 launch. Flows have cooled, though: Europe-domiciled defense ETFs had drawn about €3.0 billion of net inflows by mid-March 2026, but the year-to-date total stood at €2.4 billion by the end of May, implying net redemptions through the spring. ESG mandates are a newer source of demand. After the European Commission clarified that sustainable-finance rules do not exclude defense, average defense exposure in actively managed Article 8 funds rose from 1.66% to 2.78% in the year to Q4 2025, and DWS and J.P. Morgan Asset Management have since loosened their ESG screens to admit the sector. The flip side is concentration: BAE Systems, Thales and Rheinmetall alone make up about 37% of the WisdomTree fund, so passive money moves the same few names in and out together. With Rheinmetall down sharply and BAE up in 2026, investors are now paying for delivery, not just exposure.
The assets managers are lowering the barriers to owning defense while getting more selective about which stocks they own. J.P. Morgan Asset Management removed its conventional-weapons exclusions across 129 UK and European funds in February 2026, including its two largest European ETFs ($13bn and $10bn). Fidelity International describes the sector as being in a structural upcycle, but warns that European defense now trades on price/earnings multiples similar to those of US tech. The pattern is the same everywhere: the barriers to owning defense are coming down, and the bar for owning a particular stock is going up.
Evalueserve helps buy-side investors and asset managers turn complexity into conviction. By combining deep sector expertise, advanced GenAI platforms and rich data assets, we accelerate research, financial modelling, valuation and scenario analysis, enabling faster insights and more informed investment decisions.
For European defense: a single “rearmament theme” has become different execution stories, and the differences now sit in cash flow statements and backlog definitions rather than headlines. We build and maintain operating models, backlog-to-revenue conversion bridges and normalised peer comparables that make those differences visible. We track budget appropriations, contract awards, guidance changes and disclosure shifts between reporting dates, so an inflection is caught when it is disclosed rather than when it is priced.
Our aerospace, defense and industrials teams support buy-side clients across screening, due diligence, fundamental research, valuation, scenario analysis and portfolio monitoring.
