Defense stocks are sliding despite rising orders. What should investors do?

Suppliers of missile components and military electronics are reporting record revenue and orders, yet defense stocks are falling. Smaller names have suffered particularly steep declines: since the war with Iran began in February, the State Street SPDR S&P Aerospace & Defense ETF (XAR), which has greater exposure to smaller companies, has lost 22.8%, while the iShares U.S. Aerospace & Defense ETF (ITA), which is more heavily weighted toward large contractors, has fallen 16.1%. Oninvest analyst Aldiyar Anuarbekov looks at what is weighing on the sector and the risks investors should consider.

One headwind is uncertainty over the U.S. defense budget after the November midterm elections. As we went to press on Friday, traders on prediction market Polymarket put the probability of Democrats winning control of both chambers of Congress at 68%. That outcome could complicate approval of President Trump’s request for $1.5 trillion in defense spending for the 2027 fiscal year. Particularly vulnerable is the $350 billion portion intended to pass through a special budget process known as reconciliation, the Wall Street Journal reports. That figure includes $54 billion for drones and $49 billion for AI.

Defense stocks have moved almost in lockstep with Trump’s political fortunes, Vertical Research Partners analyst Robert Stallard notes. Defense spending traditionally enjoyed bipartisan support, but the current administration has turned defense into a partisan issue.

This does not necessarily mean spending will fall versus the 2026 fiscal year. According to the WSJ, industry analysts expect a budget above the previous $1 trillion but below the president’s proposed $1.5 trillion. For markets, that raises the risk that the most optimistic expectations will have to be revised.

High interest rates are adding pressure. With the budget deficit expected to exceed 6% of GDP, they are fueling concerns about the government’s ability to fund spending, Capital Alpha Partners analyst Byron Callan told the WSJ. Another factor is growing supply in the market: according to Capital Alpha Partners, there have been six defense IPOs in the U.S. and five in Europe this year. Most stocks have fallen since their debuts.

The selloff has brought down some companies’ valuation multiples. RBC Capital Markets analyst Ken Herbert highlights suppliers with exposure to multiple types of equipment and weapons. He cites Karman, which makes systems for missiles, interceptors, drones, and spacecraft, and Mercury Systems, which supplies computing equipment and electronics for aircraft, ground vehicles, and missiles.

According to the WSJ, as of Tuesday, Karman and Mercury Systems traded at around 40 times forward annual earnings, versus averages of about 100 and 60, respectively, in Trump’s second term.

Oninvest examined three other suppliers of components and materials for aviation, space, and defense systems. According to Yahoo Finance data as of Thursday, Ducommun trades at around 30 times forward annual earnings, Frequency Electronics at 32 times, and Park Aerospace trades at about 35 times, according to LSEG data. For comparison, Karman’s forward price/earnings ratio is around 36, versus 34 for Mercury Systems.

Ducommun (ticker: DCO)

Ducommun, with a market capitalization of about $2.4 billion, supplies structures and electronics for aviation, space, and defense programs. In the second quarter, missile revenue rose 68% year over year, with the PAC-3 program accounting for a substantial portion of the growth. Remaining performance obligations reached a record $1.2 billion. Missiles, radar, and electronic warfare systems together generate more than 20% of the company’s total revenue, according to remarks by Ducommun’s CFO.

The company’s programs include the PAC-3, SM-6, and F-15. Commercial aerospace also plays an important role: revenue in that business rose 16% in the second quarter as Boeing and Airbus increased aircraft production.

In October, Guggenheim initiated coverage of Ducommun with a “buy” rating at a target price of $246 per share. That implies almost 54% upside from Thursday’s close.

The stock has lost almost 10% over the last three months. According to MarketWatch data, it has six “buy” calls from Wall Street analysts versus one “hold.” The average target price of $219.70 per share implies about 37% upside.

Park Aerospace (PKE)

Park Aerospace, with a market capitalization of about $600 million, produces composite materials for the aerospace industry. They are used in structures for jet engines, civilian and military aircraft, drones, and helicopters.

In the second quarter of fiscal 2027, ended August 30, revenue rose 26.9% year over year to $20.8 million, while net income increased 88.6% to $4.5 million.

Park Aerospace stock has fallen 25% over the last three months. It has two “buy” ratings from analysts, according to MarketWatch data. The average target price of $42.50 per share implies 66% upside from the last close.

Frequency Electronics (FEIM)

Frequency Electronics, with a market capitalization of about $700 million, develops precision time and frequency generation devices. They are used in commercial and U.S. government satellites, as well as command, communications, intelligence, and electronic warfare systems.

In the first quarter of fiscal 2027, ended July 31, revenue rose 70% year over year to a record $23.5 million. Its funded order book reached a record $129 million. The company is heavily dependent on government programs: in the fiscal year ended April 30, direct U.S. government contracts and subcontracts for government end-use accounted for about 91% of sales. Lockheed Martin, L3Harris, and Boeing each generated more than 10% of total revenue.

Frequency Electronics stock is now trading almost 65% higher than a year ago. Over the last month, however, it has lost almost 30%. It has two ratings, one “buy” and one “hold,” according to MarketWatch data. The average target price of $95.50 per share is 55% above Thursday’s closing price.

This text is for informational purposes only and does not constitute personalized investment advice.