Defense investors reassess valuations as warfare shifts toward AI systems

Defense companies tied to AI, drones and electronic warfare may warrant different valuation treatment from traditional weapons makers, Panmure Liberum strategist Joachim Klement told CNBC on Monday. The reassessment comes after a strong multi-year run for European defense shares and a recent pullback that Klement linked partly to investor flows into artificial intelligence stocks.

Speaking on CNBC’s “Squawk Box Europe,” Klement said the geopolitical backdrop still supports demand for defense spending, but investors are starting to separate companies by the types of programs they serve. Government budget commitments remain central, but the market is also asking whether spending reaches conventional platforms or newer systems built around software, autonomy and electronic capabilities.

“Electronic warfare is a tech phenomenon,” Klement told CNBC. “These companies need to be traded like tech companies.” He said some businesses in the sector could justify “much, much higher” valuations than companies concentrated in conventional military equipment.

Procurement risk divides the sector

The shift matters because defense orders can depend on long procurement cycles, political priorities and the technical relevance of a platform. A company exposed to a delayed or cancelled program may not benefit from higher national defense budgets in the same way as a supplier aligned with technologies governments decide they need more urgently.

Klement pointed to Germany’s cancellation of the F126 program as evidence that rising defense budgets do not remove risk for large legacy projects. He said slow, costly programs can face pressure when military needs change.

He argued that Europe’s defense industry remains heavily weighted toward conventional equipment such as tanks and artillery. In his view, Germany and Rheinmetall have not placed enough emphasis on AI-enhanced and drone-enhanced systems, while he cited Italy’s Leonardo and the U.K.’s BAE Systems as examples of companies developing systems using AI and drone technology.

Klement said military planners can be too focused on prior conflicts rather than future requirements. The implication for equity markets is that broad exposure to rearmament may no longer be enough to sustain uniform gains across the sector.

Spending still spans old and new systems

Other industry specialists have described European defense spending as broad-based. McKinsey senior partner Hugues Lavandier told CNBC last month that spending in Europe is occurring across conventional land equipment, including main battle tanks and ammunition, as well as naval platforms such as aircraft carriers and frigates.

Lavandier also told CNBC that investment is increasing in newer capabilities, including deep strike, anti-drone systems and unmanned platforms. That mix suggests governments are not abandoning conventional procurement, but are adding categories shaped by lessons from recent conflicts and emerging technologies.

European defense shares have been among the most visible market beneficiaries of the region’s rearmament drive over the past five years. Recent weakness in some leading names, however, has raised questions over whether the trade is entering a more selective phase.

Klement told CNBC that he sees the recent pressure as more about capital flows than weakening fundamentals. He said many fund managers have limited cash, while companies such as Alphabet and SpaceX have recently drawn large amounts of capital in AI-related trades.

“When we look at the fundamentals, the European rearmament drive continues unabated,” Klement said, adding that Germany and Poland are increasing defense spending. His comments frame the sector’s current debate as one of allocation: which companies can convert higher budgets into orders for systems governments now regard as strategically relevant.

This story draws on original reporting from CNBC.