Defense Stocks Still Cost Too Much in 2025

2024 was a good year for defense stocks. From Jan. 1 through Dec. 30, 2024, the S&P Aerospace & Defense ETF (NYSEMKT: XAR) scored an impressive 30% gain, outperforming even the broader S&P 500 and its impressive 26.5% performance. That's the good news.

The bad news is that when stocks go up a lot, they get more expensive, and might not be such good bargains anymore. Three months ago, I concluded that this had become the case with defense stocks. I warned investors that defense stocks cost too much, and you won't believe what happened next.

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Defense stocks just got cheaper

Three months later, eight of the 10 big defense stocks I reviewed in that column have seen their price-to-sales ratios slashed. The two exceptions -- the two defense stocks that got more expensive over the last three months -- are Kratos Defense and Security (NASDAQ: KTOS), which won a big Pentagon contract early this month, and, believe it or not, Boeing (NYSE: BA).

Why did defense stock valuations slide?

I seriously doubt it was just because I pointed out the sky-high valuations in the sector. Partly, I suspect, defense stocks fell because most stocks fell. Over the last three months, the S&P itself is down a fraction of a percent. Partly, it probably had something to do with the election, and investors anticipating the incoming Trump administration might cut defense spending (for example, by cutting military support for Ukraine).

But partly, I believe defense stocks may have fallen precisely because they cost so much. And here's the thing:

They still cost too much.

Image source: Getty Images.

Defense stocks' historical valuation

Let's recap the argument I made back in October. To decide whether defense stocks currently cost "too much," I compared the average valuation of 10 popular defense stocks over the 10-year period running from 2004 to 2013, over the 10 years from 2014 to 2023, and also over the entire 20-year period. To do this, I mined data on the stocks' average enterprise-value-to-sales ratio from my favorite financial data provider, S&P Global Market Intelligence.

(The enterprise-value-to-sales ratio, by the way, is just a fancy way of calculating price-to-sales ratios, and adjusting them for whether a stock has more cash than debt on its balance sheet.) Here's how those numbers look:

Data source: S&P Global Market Intelligence. *Huntington Ingalls data begins in 2011, the year when Northrop Grumman spun off Huntington Ingalls as a separate company. **Leidos data begins in 2006, the year of its IPO. Data on its average enterprise value-to-sales ratio for 2014 is missing because the company changed its fiscal year in 2015, skewing the data somewhat.

Next, I compared these stocks' valuations today, again calculating enterprise-value-to-sales ratios (to keep the comparison apples-to-apples), but also providing price-to-sales valuations (because those are easier for most investors to find and quality-check):

Data source: Yahoo! Finance.

What this means for defense stock investors

So what can you conclude from the above? Well, the first and most surprising fact is that one of the 10 stocks named up above now costs less than its average valuation over the last 20 years: Textron shares that averaged an enterprise value of 1.24x sales over the last 20 years cost only 1.18x sales today. That's hardly a screaming bargain, but in a world of overpriced defense stocks, it still looks relatively cheap.

As for the rest of these stocks, however, they may not be quite as overpriced as they were three months ago, but they still cost too much -- certainly more than they've historically cost. So my prediction today, just like three months ago, is that on average, defense stocks will continue to underperform the broader stock market.

Feel free to check back in another three months, and let me know if I was wrong.

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Rich Smith has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends L3Harris Technologies. The Motley Fool recommends Lockheed Martin, RTX, and Textron. The Motley Fool has a disclosure policy.