Even After Trump's Tariff Turmoil, Defense Stocks Cost Too Much

The defense sector has long been a haven for investors seeking stability amid geopolitical volatility. Yet, even as companies weather the storm of former President Trump’s protectionist trade policies, the numbers tell a stark story: many defense stocks are now trading at levels that strain traditional valuation metrics. Despite their resilience, the sector’s high prices may be masking risks that could undercut returns.

Valuation Metrics Signal Overheating

The defense sector’s premium pricing is most evident in its valuation multiples. Consider the price-to-earnings (P/E) ratios of leading players:

• Lockheed Martin (LMT) trades at 21x current earnings, with a forward P/E of 17x—still above the sector average of 25x but reflecting investor concerns.
• Northrop Grumman (NOC) sits at 17x P/E, aligned with historical averages, but its backlog of $94 billion in contracts has not yet translated into higher margins.
• Boeing (BA) and General Dynamics (GD), however, face steeper challenges. Their enterprise-value-to-sales (EV/S) ratios of 2.38x and 1.77x, respectively, are well above their 20-year averages, signaling overvaluation even as they navigate commercial aviation headwinds.

The broader market context amplifies these concerns. The S&P 500’s cyclically adjusted P/E (P/E10) of 32.6 as of April 2025—historically high—suggests investors are pricing in optimism across sectors. But defense stocks are overvalued even within this elevated framework. For instance, Kratos Defense & Security (KTOS), a smaller player with recent contract wins, trades at an EV/S of 4.07x, nearly double its historical norm.

Tariffs: A Double-Edged Sword

While defense companies have largely shielded their core operations from Trump’s tariffs, the sector’s commercial arms are not so lucky.

• Raytheon Technologies (RTX) faces $850 million in added costs for 2025, driven by tariffs on its commercial divisions (e.g., Pratt & Whitney engines). Though mitigation strategies like USMCA exemptions are in place, delays in cost recovery—highlighted by CFO Evan Scott—could strain margins.
• Boeing (BA)’s $500 million in tariff-related costs are concentrated in its commercial aircraft business, raising questions about its ability to sustain premium valuations amid trade tensions.

The defense sector’s reliance on government contracts has insulated pure-play firms like Lockheed and Northrop. Their cost-plus and fixed-price contracts, which often shift risks to the government, provide a buffer. Yet this insulation is not foolproof. L3Harris Technologies (LHX), for example, trades at an EV/S of 2.50x—17% above its historical average—despite no “meaningful” tariff impact. Analysts argue this premium overvalues its growth prospects.

Analysts Sound the Caution Bell

The consensus is clear: defense stocks are “too expensive” relative to fundamentals. Key concerns include:

1. Overextended Multiples: The sector’s average EV/S ratio of 2.06x sales in 2025 is 47% higher than its 20-year average of 1.40x, with only Textron (TXT) trading below its historical norm.
2. Fiscal and Political Uncertainty: Rising U.S. budget deficits and potential cuts to defense spending—particularly for Ukraine support—could reduce demand. Meanwhile, European defense budgets, though robust, may face trade-off pressures.
3. Private Equity Activity: While buyout firms are targeting North American defense firms, deals are concentrated in companies with dual-use revenue streams (e.g., commercial and military). This suggests skepticism about pure defense plays’ standalone value.

Contrarian Optimism, But Risks Loom

Some analysts highlight pockets of value, particularly in Lockheed and Northrop. Their strong backlogs and alignment with modernization priorities—such as AI and space defense—offer hope. Yet even here, risks loom.

• Lockheed’s 2025 backlog: While substantial, its F-35 program faces unit cost overruns of 11% since 2020 due to supply chain bottlenecks.
• Northrop’s 5% foreign supply chain exposure: Though minimal, any disruption to European suppliers could ripple through its systems.

Conclusion: Proceed with Caution

Defense stocks are not cheap, and their valuations may be pricing in a future of perpetual geopolitical tension and unlimited fiscal largesse. Key data points underscore the risks:

• Sector-wide EV/S ratios are 47% above historical averages, with only Textron offering a discount.
• Analyst warnings: 62% of institutional investors surveyed by Bloomberg see defense stocks as overbought, citing unsustainable P/E ratios without earnings growth.
• Macroeconomic headwinds: Rising interest rates could compress P/E multiples, while global recessions could reduce defense spending.

While the sector’s long-term fundamentals—driven by modernization and regional rearmament—are strong, investors should avoid chasing momentum. Selectivity is critical: focus on firms with cost-plus contracts, diversified revenue streams, and exposure to high-priority programs. For others, the valuation math suggests a wait-and-see approach—or a pivot to cheaper sectors.

In an era of geopolitical risk, investors are right to seek stability. But overpaying for it could turn today’s defense stocks into tomorrow’s disappointments.