Small Defense Firms Surge 34% on Pentagon's Tech Shift

This year, small defense companies in the United States have emerged as standout performers on Wall Street. The driving factors behind this surge include the increasing demand for low-cost next-generation military technologies tailored for modern warfare and the Pentagon's strategic shift towards "flexible adaptive combat systems."

The conflicts in Ukraine and Gaza have driven global defense spending higher, boosting overall defense stocks and attracting investor interest in small firms specializing in "AI-driven drones" and "unmanned equipment." These systems are cost-effective, easy to deploy, and help reduce reliance on ground troops.

“In this new market, the winners will be companies that adapt to change and invest in low-cost, upgradable, and software-driven weapon systems,” said the director of aerospace and defense at Stifel Financial Company.

The NYSE Arca Defense Index has risen approximately 34% year-to-date, significantly outperforming the 12% gain of the S&P 500. Among the top 10 performers in this index since 2025, seven are mid-cap companies. Leading the pack are drone manufacturer Kratos Defense & Security Solutions, AeroVironment, Astronics, and Mercury Systems.

Even traditional large defense companies have seen gains this year, with RTX rising about 37% and Northrop Grumman up 23%.

“This administration has made it clear that we need to provide equipment to our warfighters at a faster pace. Defense Secretary Pete Hegseth has emphasized this multiple times, and the procurement processes reflect this direction,” said the chief growth officer of AeroVironment.

President Donald Trump has ordered the renaming of the Department of Defense to the "Department of War," a change that requires congressional approval. In his 2026 fiscal year budget proposal of 892.6 billion, he requested increased investment in high-tech missiles and drones, while reducing spending on ships and fighter jets.

Nearly 60 billion has been allocated in the Pentagon's budget for "unmanned systems" and "anti-drone technology," marking a 78% increase from the previous year.

“These trends are predictable — the key is to follow the government's policy statements and, more importantly, the flow of funds,” said a senior analyst at Seaport Research Partners.

In 2025, despite a decline in total transaction value, the number of mergers and acquisitions in the U.S. aerospace and defense sector increased, indicating a shift towards smaller deals.

Large corporations are seeking cross-sector acquisitions to enhance their capabilities in communication, cybersecurity, and artificial intelligence. For instance, Lockheed Martin acquired Amentum's "Rapid Solutions Division" for 360 million to expand its radar capabilities.

Venture capital is also pouring into this sector. “The market signals are clear: there is a need for tens of thousands of low-cost ammunition and unmanned systems,” said the CEO of Divergent Technologies, a startup that provides 3D-printed components to Lockheed Martin, Raytheon, and other small defense companies.