Morgan Stanley believes U.S. defense equities present an attractive opportunity heading into 2026, arguing that current share prices do not adequately capture the outlook for continued expansion in U.S. defense spending, even amid ongoing political uncertainty.
In a sector outlook, analyst Kristine Liwag said the bank views the group as undervalued, noting that it “provides good value as stocks are not reflecting the growth in U.S. Defense budget.”
According to Morgan Stanley, demand across the defense sector is expected to keep outstripping supply growth, extending the dynamics that supported strong performance in aerospace and defense stocks throughout 2025.
Following a reassessment of valuations across the industry, the firm adjusted its recommendations on several major defense contractors. Morgan Stanley upgraded L3Harris Technologies (NYSE:LHX) and General Dynamics (NYSE:GD) to Overweight, while lowering its rating on Lockheed Martin (NYSE:LMT) to Equal-weight.
The bank also introduced a revised valuation framework for defense primes, based on an approximate “15% discount to the market on 2027 P/FCF,” with individual premiums and discounts applied depending on company-specific fundamentals.
Liwag said L3Harris was assigned the baseline discount under this framework, while General Dynamics was given a “slight premium” relative to peers. Lockheed Martin, by contrast, was assigned a larger discount due to its “relative EPS / FCF growth profile vs. peers.”
Northrop Grumman (NYSE:NOC) continues to be Morgan Stanley’s Top Pick in the defense sector, supported by what the firm described as a high-quality portfolio mix and favorable historical trading patterns.