NATO leaders have agreed to further ramp up defence spending at a summit on Wednesday, potentially providing another boost to companies operating in the sector.

Following a summit at the Hague on Wednesday, the Western military alliance issued a statement saying members had committed to increasing defence spending to 5% of their countries’ gross domestic product (GDP) by 2035.

NATO leaders said that the pledge came “in the face of profound security threats and challenges, in particular the long-term threat posed by Russia to Euro-Atlantic security and the persistent threat of terrorism.”

In addition, NATO allies reaffirmed their commitment to provide support to Ukraine, including direct contributions to the country’s defence.

European leaders have been promising to increase spending on defence, amid increasing geopolitical threats of the Russia-Ukraine war and conflict in the Middle East. There has also been increased pressure under the Trump administration for its allies to share more the responsibility for security.

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The new 5% defence spending target marks a large increase from the previous goal of 2% of GDP, which was set at a summit in 2014.

Pledges to spend more on defence have seen European stocks in the sector soar this year and there are a number that are still highly rated by analysts.

Ahead of the NATO summit this week, Germany announced that it planned to increase core defence spending to 3.5% of GDP through 2029.

In a note, published on Wednesday morning, Bank of America (BofA) research analysts said that this was above expectations, as they believed consensus was expecting Germany to increase defence spending to 3% by 2030.

“We think the market will reward names in 2H25 with exposure to countries such as Germany where financing for the defence ramp is clearly front-end loaded,” they said.

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One of the names the BofA analysts expected to benefit the most was Düsseldorf-headquarted firm Rheinmetall (RHM.DE), maintaining a “buy” rating on the stock, which has soared 177% year-to-date.

The analysts explained that Germany’s 3.5% target would mean it is set to spend more than €150bn (£128bn) on defence by 2029. “We expect c.40% of this will be spent on procurement would mean c.€60bn spent on equipment, which compares to c.€8-9bn in 2021,” they said.

BofA’s team estimated that Rheinmetall captured an average of approximately 17% of sales over 2019 to 2024 from German defence procurement.

The other name highlighted by BofA’s analysts was Hensoldt (HAG.DE), which they also maintained a “buy” rating on, with shares in the company up 171% so far this year.

The research analysts estimated that Hensoldt captured an average of approximately 8% of sales from German defence procurement over 2019 to 2024.

Hensoldt reported a strong start to the year when it released first quarter results in May, saying it had reached an order intake of €701m, compared to €665m for the same period last year.

The company’s order backlog rose 18% compared to last year to reach a fresh record of €6.93bn. Revenue for the quarter came in at €395m, up from €329m last year.

Hensoldt confirmed its guidance for the 2025 financial year, expecting revenue to be between €2.5bn and €2.6bn.

On the London market, FTSE 100-listed (^FTSE) company Babcock (BAB.L) also remains “buy” rated by BofA’s analysts according to Wednesday’s note.

Shares in the engineering company surged 12% on Wednesday, after it posted a strong set of preliminary full-year results, with CEO David Lockwood hailing a “new era for defence”.

The engineering company reported revenue of £4.8bn ($6.5bn) compared to £4.4bn last year. Babcock posted operating profit of £363.9m, up from £241.6m last year. Babcock also recommended a final dividend of 4.5p per share, taking the total payout for the year to 6.5p per share, compared to 5p last year.

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In addition, Babcock announced a £200m share buyback, which it planned to execute over the 2026 fiscal year.

Richard Hunter, head of markets at Interactive Investor, said: “With increasing military tensions firmly on the global agenda, Babcock has caught the zeitgeist in delivering a sparkling set of numbers.”

Shares in Babcock are up 130% year-to-date, compared to a 7% gain in the FTSE 100 in that time.

Hunter said that such gains in Babcock shares over the past couple of years “raises questions but an increasing commitment to defence spending, allied to a possible rerating of the sector adds an intriguing set of prospects to the mix.

“The initial share price reaction to the numbers [on Wednesday] reflects a further standing ovation, and the market consensus of the shares as a strong buy should therefore remain firmly intact.”

Shares in Rolls-Royce (RR.L) hit a fresh high on Wednesday, ahead of the NATO defence spending announcement.

The stock is up 62% year-to-date, helped by solid sets of results, with the company reporting a “strong start to the year” in a trading update in May. Despite flagging uncertainties related to tariffs and continued supply chain challenges, Rolls-Royce maintained its guidance of underlying operating profit of £2.7bn to £2.9bn for the 2025 financial year.

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According to BofA’s note on Wednesday, the bank’s analysts continue to have a “buy” rating on the stock.

Meanwhile, Deutsche Bank analyst Christophe Menard said in a note on 11 June that he was keeping a buy rating on Rolls-Royce and raised his price target from 860p to 935p. Menard’s target price raise came after Rolls-Royce was selected to provide technology for the UK’s first small modular reactor (SMR), with the government committing over £2.5bn to the programme.

“We estimate that the UK SMR programme will contribute 16p to the share price of Rolls-Royce, and there is potential for more SMR orders in the Czech Republic, Sweden, and other countries, with the global SMR market projected to be substantial.,” he said.

Another stock with a “buy” rating from BofA analysts, according to Wednesday’s note, was BAE Systems (BA.L).

Shares are up nearly 59% year-to-date, as another top performer on the UK’s blue-chip index. In a trading statement last month, BAE said it was so far trading in line with management’s expectations and maintained its guidance for the year.

For the 2025 fiscal year, BAE guided to sales growth of 7% to 9%, based on the last year’s £28.3bn. Underlying earnings before interest and tax are expected to grow by 8% to 10%, compared with last year’s £3bn.

On the back of the jump in Babcock shares on Wednesday, Susannah Streeter, head of money and markets at Hargreaves Lansdown, said: “As military tensions ratchet up across the world, as part of a geopolitical risk megacycle, the situation is set to keep prospects for defence stocks solid.

“As far as valuations are concerned, much of the spending expectations are already being baked in. Nations will also be keen to strike favourable terms for upcoming contracts, given the pressure on public purses, so are likely to try and drive a hard bargain.”

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