Rheinmetall has become the poster child of Europe’s defense boom — a 540% return over three years, a backlog stuffed with orders, and every retail investor on Reddit discussing whether it’s the trade of the decade. The stock is now trading at a PE ratio of roughly 88x, well above analyst “fair ratio” estimates of around 56x. Meanwhile, a handful of smaller defense names are sitting on double-digit revenue growth, record backlogs, and multiples that don’t require a spreadsheet acrobatic act to justify.
Defense spending isn’t a niche macro theme anymore — it’s a multi-year structural shift. Germany’s Bundestag approved a $129 billion military budget for 2026, a 45% increase over the prior year. NATO is pushing members toward 3% or more of GDP in defense spending. According to analysts at Berenberg, if NATO’s northern and eastern members hit 3.5% of GDP while others average 3%, the alliance could see up to $600 billion in additional annual spending over the coming decade, with $350 billion coming from non-US allies alone.
That’s an enormous pie. And right now, most of the capital is crowding into the six or seven names everyone already knows. The interesting opportunity — as has historically been the case in any sector surge — may lie with the second-tier suppliers, niche systems makers, and smaller primes who are winning contracts quietly while the headlines stay fixated on Rheinmetall and BAE.
Disclaimer: This article is for informational purposes only and does not constitute financial advice. All investments carry risk. Past performance is not indicative of future results. Always do your own due diligence before making any investment decision.
Why Rheinmetall’s Premium May Be Getting Crowded
Nobody is saying Rheinmetall is a bad company. Its Q4 results showed explosive growth, its CEO highlighted that their air defense systems had shot down over 100 drones in a single weekend during the Iran conflict, and its revenue conversion from backlog remains strong. The rearmament thesis is real.
But at a PE of 88x versus a sector-implied “fair ratio” of ~56x, the stock is pricing in a lot of execution. And Rheinmetall itself has acknowledged that production capacity constraints remain a binding factor — meaning the revenue ramp the market is expecting is not instant. For investors entering now, you’re paying for 2028 earnings at today’s prices, with execution risk baked in.
That valuation gap creates a window for investors to look at smaller, less-covered defense names that are already delivering growth today — at a fraction of the valuation multiple.
5 Small-Cap Defense Stocks Flying Under the Radar
1. Kratos Defense & Security Solutions (KTOS)
If there’s one US small-cap defense stock that deserves attention right now, it’s Kratos. The company reported Q4 2025 revenue of $345.1 million — exceeding the top of its guidance range of $320–330 million — with 21.9% total growth and 20% organic growth. That’s not a small-cap company creeping along; that’s a business accelerating.
What makes Kratos compelling is its positioning in unmanned systems and hypersonics — two areas that are becoming central to modern warfare doctrine. The company recently partnered with GE Aerospace on a low-cost Collaborative Combat Aircraft engine program and won a hypersonic materials testing contract that puts it upstream of other hypersonics programs. Its satellite ground systems work for OmanSat-1 adds commercial diversification.
Kratos’ 2-year stock return stands at approximately 350%, but consensus EPS growth for 2026 is estimated at nearly 42% year-over-year, suggesting the growth story isn’t over. The company carries a Zacks Rank #2 (Buy) and has outperformed its industry by nearly 7 percentage points over the trailing three-month period.
The bear case: Kratos is not cheap either — unmanned systems is a hot narrative trade and some contract wins are lumpy by nature. But compared to Rheinmetall at 88x earnings, Kratos’ growth-adjusted multiple looks far more reasonable.
2. Mercury Systems (MRCY)
Mercury Systems is a turnaround play on top of a defense-electronics growth story. After years of operational struggles, the company posted a Q4 FY2025 adjusted EBITDA of $51 million — up 65% year-over-year, alongside revenue of $273 million (9.9% growth). Full-year free cash flow hit a record $119 million.
More importantly, Mercury reported record bookings of $342 million in Q4, with a book-to-bill ratio of 1.25 — meaning for every dollar of revenue recognized, they’re booking $1.25 in new work. Total backlog has reached $1.4 billion. FY2026 guidance implies continued margin expansion toward mid-teens and low-single-digit revenue growth.
Mercury’s sweet spot is in the “sensor processing and electronic warfare” segment — the kind of embedded hardware that goes into radar systems, advanced avionics, and electronic countermeasure systems. This isn’t glamorous headline stuff, but it’s the plumbing of modern defense electronics, and demand is structurally rising across every NATO ally’s modernization program.
The company’s recent operational improvement (after a rough stretch of cost overruns and misses) makes the risk-reward asymmetry interesting: if execution holds at current levels, the stock is significantly re-rateable.
3. Ducommun Incorporated (DCO)
Ducommun is one of the less-known names in the defense supply chain — and that obscurity is part of what makes it interesting. The company reported Q4 CY2025 revenue of $215.8 million, a quarterly record, representing 9.4% year-over-year growth. CEO Stephen Oswald called out the military and space business as the growth driver.
Ducommun manufactures complex structural components, electronic systems, and electromechanical assemblies for aerospace and defense programs. Its customers include Lockheed Martin, Boeing Defense, Northrop Grumman, and the US Army — but as a Tier 2 supplier, Ducommun doesn’t get the attention its customers do.
The thesis here is straightforward: as the defense primes ramp up production to fill backlogs, their component suppliers have to scale too. Ducommun’s revenue grew nearly 10% in the quarter without the valuation premium that names like Rheinmetall or Northrop carry. The company has a market cap firmly in small-cap territory, analyst coverage is thin, and institutional ownership is building slowly — which often precedes a re-rating.
The miss on Q4 revenue by $1.8 million versus estimates (0.8% miss, but earnings beat by 15.4%) is a minor blemish, not a structural concern.
4. Moog Inc. (MOG-A)
Moog doesn’t make headlines, but it makes the precision motion control systems that guide missiles, aircraft control surfaces, and satellite positioning mechanisms. It’s an aerospace and defense company that’s been around since 1951, which means it has the cleared facility base, engineering institutional knowledge, and program relationships that newcomers can’t replicate.
The company has been quietly building momentum: defense business orders increased 61% in a recent reporting period, and 2026 guidance implies low-double-digit percent revenue growth in its defense segment. Its two-year return has been approximately 97%, roughly doubling shareholders’ money — but that’s modest compared to Rheinmetall’s 540% run, suggesting Moog hasn’t fully re-rated with the sector.
With defense customers on both sides of the Atlantic ramping up missile production and unmanned systems procurement, Moog is embedded in the supply chain for most of what they’ll buy. It’s the kind of company that benefits from every new program without needing to win the marquee contract itself.
5. Hensoldt AG (HAG.DE)
For investors willing to look at European-listed names, Hensoldt is the most compelling pure-play radar and sensor specialist on the continent — and it’s significantly less covered than Rheinmetall by English-language media.
Hensoldt is a German defense electronics company that spun out of Airbus in 2020. Its products include radar systems (including the TRML-4D used in active air defense), electronic warfare suites, and battlefield sensor networks. As Europe’s threat environment has shifted toward contested airspace, Hensoldt’s addressable market has grown substantially.
The stock (HAG.DE) has delivered approximately 67.7% total return over the last two years — strong, but roughly one-third of Rheinmetall’s run over the same period. Yet both companies are beneficiaries of the same macro tailwind: German rearmament and European air defense investment. The difference is that Hensoldt sits at a much smaller market cap with a forward multiple that reflects far less optimism.
The risk is liquidity (it’s German-listed with lower trading volumes for US investors) and the fact that its revenue growth is more back-end loaded as long-term contracts convert to deliveries. But as a complement to US holdings in the space, Hensoldt offers genuine diversification into European defense electronics at a valuation that hasn’t been bid into the stratosphere.
The Macro Backdrop Remains Strong — But Not All Beneficiaries Are Equal
The structural case for defense spending is not in question. Between the ongoing Russia-Ukraine conflict, the recent Iran war driving fresh air defense demand, China-Taiwan tensions, and NATO’s push toward 3%+ GDP targets, defense procurement is in a multi-year upcycle. Germany alone is adding nearly €40 billion per year to reach its 3% target — an amount equivalent to France’s entire annual defense budget.
But in any sector boom, capital tends to flood the most visible names first. That creates a compression at the top (Rheinmetall, BAE Systems, Lockheed Martin trading at full or extended multiples) and a dispersion opportunity at the next tier. The companies profiled here are not speculative moonshots — they have real revenues, growing backlogs, and verifiable contract relationships with defense primes and direct government customers.
The question isn’t whether the macro works. It clearly does. The question is: do you want to pay 88x earnings for Rheinmetall, or would you rather own the companies building its components at a meaningful discount to the same thesis?
If you’re building a defense portfolio in 2026, a barbell approach may make the most sense — a core position in the well-known large caps paired with a handful of smaller names where analyst coverage is thin and the market hasn’t fully priced in the backlog build. The upside on re-rating alone can be substantial, even without any additional macro tailwind.
This site has covered related themes including the UAMY defense contract and antimony supply chain story, which highlights how critical materials contracts are increasingly flowing to small-cap US companies. Similarly, the Planet Labs defense space trade thesis illustrates how intelligence, surveillance, and reconnaissance demand is creating new winners in the small-cap space. Both articles are worth reading alongside this one to get a fuller picture of where defense dollars are flowing in 2026.
Risks Worth Watching
No investment thesis is complete without acknowledging what could go wrong. Key risks in the small-cap defense space include:
- Program delays and cancellations: Smaller suppliers are more exposed when a major contract gets restructured or cut. Government program timelines are notoriously inconsistent.
- Dilution risk: Some smaller defense companies fund growth through equity issuance, which can erode per-share value even as top-line revenue grows.
- Geopolitical resolution: A ceasefire in Ukraine or a rapid conclusion to the Iran conflict could temporarily cool defense spending sentiment — not the structural trend, but near-term sentiment-driven pullbacks can be sharp.
- Currency risk (for European names like Hensoldt): USD/EUR movements affect both returns and the relative attractiveness of European defense spending pledges.
Bottom Line
Rheinmetall is a great company. It might even justify its premium valuation over the long term. But the most interesting risk-adjusted opportunities in the defense sector right now may be one rung down the market cap ladder — in the Tier 2 suppliers, the defense electronics specialists, and the niche primes that are growing revenues in the high single to low double digits while trading at a fraction of the attention Rheinmetall receives.
Kratos (KTOS), Mercury Systems (MRCY), Ducommun (DCO), Moog (MOG-A), and Hensoldt (HAG.DE) all have legitimate claims to the same macro tailwind that’s sent Rheinmetall to €1,450+ per share. None of them have been re-rated to reflect it fully. That gap between fundamentals and valuation is where small-cap investors traditionally find their edge.
Disclaimer: This article is for informational purposes only and is not financial advice. The author does not hold positions in any securities mentioned. Always conduct your own research and consult a qualified financial professional before making investment decisions.