Will defense stocks become the next big thing?

Defense stocks are regarded by investors as having the best growth prospects

Who are the main players?

According to new research, investors' top growth hope appears to be defense stocks, which are overtaking US big tech.

(LON:RR) Rolls-Royce. topped the Interactive Investors platform's June list of the best stocks, followed by BAE Systems (LON:BA). arrived at number five. Going forward, as investors turn to the defense sector to provide the kind of growth they are accustomed to from big tech, we may see even more defense stocks join these businesses.

On July 31, Microsoft joined Nvidia in becoming a member of the exclusive £4 trillion market cap club. For almost three years, investors' attention has been focused on the Magnificent Seven stocks.

But amid a rotation away from US stocks, and in light of unprecedented spending commitments from European nations, could defence stocks be the next source of growth for investors?

Twice a year, trading platform IG polls its users to determine how UK retail investors feel about the stock market.

According to the most recent data, investors in the UK believe that over the next six months, the defense and military industry will grow at the fastest rate, overtaking artificial intelligence (AI).

"Even though AI sentiment is still positive, the defense industry's drivers are more powerful than ever, and investors are obviously taking notice of that momentum," Chris Beauchamp, chief market analyst at IG, stated.

According to IG's survey of 1,800 clients, 55% of them placed defense stocks in their top three sectors for anticipated growth over the next six months.

Image: Instagram.

Are defense reserves increasing?

This year, investors' attention has been drawn to industry heavyweights like Rolls-Royce and BAE Systems, and the fundamentals support the optimism.

The growth that BAE Systems is experiencing was highlighted in its half-year results, which were released on July 30. Revenue climbed 11% year over year to £14.06 billion, while underlying EBIT increased 13% to £1.55 billion.

Victoria Scholar, head of investment at Interactive Investor, stated at the time, "With its exposure to long-term contracts, there were some concerns earlier in the year that investor enthusiasm around BAE Systems was starting to falter, but today's update proves there is still reason to be optimistic towards the stock."

Rolls-Royce's half-year results, which were released on July 31, showed a 50 percent increase in underlying operating profit to 1 point7 billion and an 11 percent increase in revenue to 9 point1 billion year over year. The company also increased its full-year guidance from 2 point7-2 point9 billion to 3 point1-3 point2 billion.

The next session saw an 8-point 5-percent increase in Rolls-Royce shares. Rolls-Royce's stock has increased 91.7 percent this year as of the close on August 4.

Prospects for defense stocks in Europe.

Due in large part to US President Donald Trump's seemingly lax approach to the NATO alliance, European companies have benefited greatly from the surge in defense stocks.

Scholar stated that "European defense companies have performed well under Trump's presidency and amid the backdrop of global instability with the wars in Ukraine and the Middle East."

As a result, there are worries that the recently announced EU-US trade agreement may signal a return to closer US-European ties, particularly given Trump's concurrent adoption of a more assertive posture toward Russia.

However, Morningstar equity analyst Loredana Muharremi thinks the recent EU-US trade agreement may help European defense stocks, even if it gives US companies in the industry more advantages.

"The EU tariff deal is not a bad thing for European defense," she stated. In actuality, it supports our belief that the US defense industry will remain a vital component of Europe's defense ecosystem.

Muharremi anticipates that the trade agreement will mean that "over time the share of equipment from the US will decrease, in favor of European primes," but European countries would have had to continue purchasing from the US due to capability gaps and the pressing need for off-the-shelf equipment.

How to make defense stock investments.

Investors can purchase defense stocks through an ISA.

An investment trust or defense fund may be a good option for investors who wish to expand their exposure to defense stocks without concentrating on just one or two stocks.

The Future of Defence UCITS ETF (LON:NATO) is one such. With all holdings based in NATO or NATO-allied nations, this exchange-traded fund (ETF) provides exposure to a portfolio of forward-thinking businesses with a defense theme and are vetted for NATO alignment.