The word most associated with the defense sector over the past decade was stable. Predictable revenues, government contracts, modest growth — a value investor's safe harbor. That characterization is now obsolete.
In a recent episode of MFS Investment Management's (MFS) All Angles podcast1, Sean Kenney, EVP and Head of Global Distribution, sits down with Elizabeth McGuire, MFS Equity Research Analyst covering aerospace and defense as well as nuclear and renewable energy. What emerges is a meticulous, bottom-up portrait of a sector undergoing a once-in-a-generation transformation — not driven by a single conflict or policy shock, but by structural forces that are compounding across geographies, contract structures, and technology platforms.
MFS, a key sub-advisor to Sun Life Global Investments, brings the kind of globally integrated, cross-sector research depth that a sector this complex demands. The defense conversation McGuire and Kenney conduct illustrates precisely why.
The Scale of the Shift
The numbers are the starting point. In 2025, global defense spending reached $2.6 trillion — up 6% over 2024. That headline figure, however, understates the acceleration happening beneath it.
"The biggest acceleration is happening in Europe and the UK," McGuire notes. "And for the US as well — these US primes have 10% to 25% of sales from international countries, and those can be higher margin as well."
If 2025 was Europe's inflection year, 2026 belongs to the Middle East. McGuire cites Saudi Arabia, Israel, and the UAE as active buyers of radar, missiles, and helicopters, with nearly $30 billion in foreign military sales notifications already logged — much of it transacted before the most recent regional escalation. A shift in U.S. policy posture under the Trump administration has opened access to markets that were previously constrained, accelerating deal flow.
In the U.S. itself, two landmark programs define the new spending envelope: the $185 billion Golden Dome missile defense initiative and the Next Generation Air Dominance program — the F-47 sixth-generation fighter jet. These aren't incremental line items. They are long-cycle, capital-intensive commitments that will shape procurement for years.
Early Innings, Long Duration
McGuire is unambiguous about where the defense cycle stands. "I'd articulate it as we're in the first or second inning of the up cycle." That framing carries significant implications for investors oriented toward duration.
The structural constraints of the industry itself function as an earnings extension mechanism. Weapons systems take years to build. Prime contractor backlogs already stretch out multiple years. Missile production capacity is being expanded, but manufacturing infrastructure cannot be conjured quickly in an industry that hasn't historically been a growth sector. "There's just practical limits in an industry that hasn't been a growth industry historically to how quickly we can scale up production," McGuire says. "That will in and of itself be kind of an arbiter — we won't double overnight."
This isn't a liability. For long-duration investors, the inability to ramp overnight is what creates earnings visibility. The growth cannot be front-loaded. It distributes across time, producing sustained compounding rather than a single-quarter burst.
Kenney frames it clearly: "What we hear consistently is with our growth teams, rate and duration matter — so obviously the growth rate is a big deal, but having confidence in the duration is a big part of how we think about investing."
Contract Architecture as a Competitive Moat
The transformation isn't only in how much governments are spending — it's in how they're spending it. Contract structures are being fundamentally redesigned in ways that directly benefit equity investors.
"We're seeing big changes in how the contracting is done," McGuire explains. "We're seeing the government committing to longer-term contracts — this has happened first in missiles in the US with up to seven-year commitments. And there's talk of extending that beyond missiles."
Germany has followed a similar path. More significantly, governments are now sharing in upfront capital investment required for capacity expansion — a structural concession that reduces financial risk for defense contractors and lowers the cost of scaling. "If there's a big investment required for this capacity expansion, the governments are being willing to share in some of that upfront capital investment, which is new as well," McGuire notes.
"Visibility of growth is important as we think about valuation," she adds. "Having that multi-year visibility, especially as being as long-term as we are here at MFS — that's a big deal."
Neo-Primes and the Innovation Premium
The sector's growth story has a technology layer that is reshaping competitive dynamics from the ground up. McGuire identifies a new class of entrants — neo-primes — that are challenging established contractors on both cost and capability.
"Some of it is just producing similar weapons faster and cheaper," she observes. York Space Systems, which IPO'd in January, builds satellites at 50% of what traditional primes charge. SpaceX has structurally repriced launch economics. These are not incremental improvements — they are deflationary shocks to legacy cost structures.
The second category is capability innovation, where autonomy and uncrewed systems dominate. Drones, autonomous ocean systems, AI-enabled platforms — the Ukraine conflict has demonstrated operational proof-of-concept for many of these technologies at scale.
The IPO pipeline is building. McGuire expects a significant cohort of defense tech listings in the coming year, concentrated in drones and space. MFS monitors private companies — including Anduril, a leading autonomy firm — through direct engagement, attending meetings alongside both growth and value portfolio managers. "The growth portfolio managers interested in what they're doing and the disruption," she notes, "and then the value portfolio manager trying to understand — is this a threat? How soon? To what parts of the business?"
Valuation: Two Frameworks for Two Different Businesses
McGuire applies a deliberately bifurcated valuation lens across the sector.
Traditional defense primes trade at elevated multiples relative to historical averages — but the fundamental picture has also materially improved. Free cash flow generation remains a distinguishing characteristic of the legacy primes, and on that metric, the defense sector still trades at a discount to the S&P 500. Importantly, defense equities offer portfolio construction value beyond their earnings profile: "The defense sector is relatively insulated from both the CapEx required to build out the AI infrastructure and the risk of businesses being disrupted by AI. That also has implications on valuation."
For neo-prime defense tech companies — pre-profitability, pre-free-cash-flow — the framework shifts entirely. "We will look at forward sales multiples, think about the total addressable market, maybe not just products they have today, but products that might launch in the future. That is much more of an early stage company valuation exercise."
Key Risks
McGuire is precise about the risk factors that could disrupt the thesis. Fiscal constraints are real — government budgets are finite, and defense spending competes with non-defense priorities. Midterm elections in the U.S. and political cycles across Europe introduce policy variability. And production capacity constraints could create a gap between demand authorization and actual delivery. "The dollars are there, the demand is there — but can we ramp up production?"
These are not reasons to exit the sector. They are the variables that define the difference between understanding the investment and owning a theme.
5 Key Actionable Takeaways for Advisors and Investors
1. Position for a multi-year cycle, not a geopolitical trade. McGuire's "first or second inning" characterization signals that the defense upcycle has structural, not episodic, underpinnings. Advisors should frame exposure as a long-duration allocation, not a tactical position.
2. Longer contracts mean more visible earnings — favor companies with growing backlogs. The shift to multi-year government commitments, including up to seven-year missile contracts in the U.S. and similar structures in Europe, creates the kind of earnings predictability that supports premium valuation multiples and reduces reinvestment risk.
3 Apply different valuation frameworks to traditional primes versus neo-primes. Legacy defense contractors warrant free-cash-flow-based analysis; defense tech companies require a total addressable market and forward revenue approach. Treating them the same produces mispricing errors in both directions.
4. Don't ignore the AI-uncorrelated portfolio construction benefit. Defense equities are structurally insulated from both AI infrastructure spending exposure and AI disruption risk — a rare characteristic in the current market. This asymmetry has genuine portfolio diversification value.
5. Watch the IPO pipeline in drones and space. The monetization of private defense tech is accelerating. Advisors and portfolio managers should track upcoming listings in autonomous systems and commercial space, where the gap between private market scale and public market access is closing rapidly.
The views expressed are those of the speakers and are subject to change at any time. This material is for informational purposes only and should not be relied upon as a recommendation to purchase any security or as investment advice. No forecast can be guaranteed. Past performance is no guarantee of future results.
Footnote:
1 "Visible Earnings: Financing the Future of Defense." MFS, May 2026.
