Defence stocks are the darlings of the market once again; can the rally hold its ground?

Defence stocks, once the darlings of the market, are back again in the spotlight. After a sharp correction in 2024 following a stellar multi-year run, the sector is seeing a smart recovery. Renewed investor interest has been fuelled by a combination of rising defence budgets, strong order books, and the government’s continued push for indigenous defence manufacturing.

From a long-term perspective, the numbers are impressive. Between FY17 and FY24, India’s defence production value nearly doubled to ₹1.27 lakh crore, while exports surged 15 times to ₹21,000 crore. Today, the companies in the Nifty India Defence Index hold a combined order book of over ₹3.5 lakh crore, indicating solid revenue visibility ahead.

Varun Gupta, CEO of Groww Asset Management, notes that the sector’s impressive five-year CAGR is not just sentiment-driven. “It’s also a result of improving financials, rising order books, and strong policy support,” he says. Structural reforms like the Defence Acquisition Procedure 2020 and the Positive Indigenisation Lists are laying the foundation for a robust local defence ecosystem, according to Gupta.

“While valuations in the sector have expanded, they are underpinned by improving financials, growing order books, and deep policy support. Long-term structural reforms like the Defence Acquisition Procedure 2020, Positive Indigenisation Lists, and the creation of Defence Industrial Corridors in Uttar Pradesh and Tamil Nadu are building a holistic domestic defence manufacturing ecosystem within the country. On the budgetary front, historically, India’s defence budget has remained a high priority—election year or not—with allocations growing every year and more than doubling in the past decade. Recent geopolitical events have further sharpened the government's focus on national defence and reinforced its strategic importance,” adds Gupta.

However, investors need to tread with caution. Kaustubh Belapurkar of Morningstar warns that defence-themed funds are highly concentrated. “Sector funds tend to be extremely concentrated exposures, which is particularly true for the Defence Index, with the top three stocks accounting for 50%+ of the index and the top five holdings for 70%+. This makes the returns of the funds/index very lumpy and driven by the price movement of only a handful of stocks. Investing in these funds is fraught with timing risk, with entry and exit timing being very crucial,” he explains. For most investors, diversified equity funds may offer a safer route.

Valuations in the sector have definitely run up, but believers in India’s defence story are being advised to take the SIP route for steady long-term participation. “We look at defence as a long-term structural story and suggest SIPs as a prudent way of participating in this long-term growth story while navigating short-term volatility and elevated entry points,” adds Gupta.

Defence remains a structural theme, but staying grounded with a long-term view is key.