BAE Systems and Babcock International have been among the defining stories of the FTSE 100 in 2026, and the question that investors are increasingly asking — not whether the structural demand case remains intact, but whether the valuations already reflect it — has become the most pressing issue in the UK defence sector.
BAE, Britain’s largest pure-play defence manufacturer, closed the week with a fall of 2.8% on Friday, underperforming the broader index, while Babcock has pulled back approximately 16% from its peak over the past month even as its fundamental narrative of surging government demand remains as strong as at any point in recent memory.
BAE’s full-year results in February told a strong underlying story: underlying operating profit up 12% to £3.32 billion in 2025, beating analyst forecasts, with a record order backlog of £83.6 billion and guidance for 2026 sales growth of 7% to 9% alongside operating profit growth of 9% to 11%.
Chief Executive Charles Woodburn described the current environment as “a new era” of defence spending, and he had the numbers to support the characterisation. The problem for investors approaching the stock now is not the business quality but the multiple being paid for it.
BAE trades on a forward price-to-earnings ratio approaching 30, well above the FTSE 100 average of around 17, and that premium requires the strong earnings trajectory to continue and the geopolitical tailwind to persist — neither of which is guaranteed.
Babcock’s case is similar in structure but different in degree. The company’s first-half results showed underlying profits up 19% to £201 million, driven by revenue growth and a 90 basis point improvement in operating margins to 7.9%. Its order backlog now stands at £9.9 billion, a figure that provides multi-year revenue visibility across its naval, engineering, and defence services divisions. Over twelve months Babcock shares are up approximately 60%, and over five years the gain exceeds 400%, a performance driven by the combination of the company’s successful turnaround from near-crisis several years ago and the structural rerating of the entire defence sector as European governments have accelerated rearmament programmes. At a market capitalisation of around £7.3 billion, it remains considerably smaller than BAE’s £60 billion, which supporters argue leaves more room for continued re-rating.
Citigroup strategist Beata Manthey described European defence stocks this week as becoming a “strong structural addition” to portfolios rather than simply a temporary shelter from geopolitical shocks, pointing to the sustained nature of government spending commitments across the UK and the continent. The UK’s stated trajectory from 2.5% of GDP in 2027 to 3.5% by 2035 — and the possibility that Starmer’s political pressures accelerate that timeline — provides a multi-year demand backdrop that neither company has fully exploited in earnings terms yet. The distinction between BAE and Babcock is partly one of scale and partly one of momentum: BAE’s shares have been broadly flat over the past month despite the defence spending rhetoric, while Babcock has corrected more sharply from its highs, creating a valuation gap that some investors find more compelling on a risk-adjusted basis.