3 ASX Defence Stocks Set to Benefit in 2026 from Rising Military Budgets

ASX Defence Stocks: 3 Names to Watch in 2026

Global defence spending reached a record US$2.7 trillion in 2024, the steepest annual increase since the Cold War. For Australian investors, this isn’t just a headline; it’s a structural shift with real implications. Australia’s defence budget is growing at 5.9% annually, with nearly A$2.7 billion earmarked for AUKUS submarines in 2025-26 alone. Defence spending appears to be a multi-year tailwind rather than a one-off surge.

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Why Defence Spending Is a Multi-Year Tailwind

All 32 NATO allies are now expected to meet the 2% GDP spending target in 2025, compared to just three nations in 2014. European defence budgets surged 17% in 2024, and NATO has agreed to a new 5% of GDP target by 2035. This represents a fundamental shift in government priorities globally. Counter-drone systems, directed energy weapons, and naval capabilities are receiving outsized investment, suggesting tailwinds that could persist for years.

3 ASX Defence Stocks to Watch

DroneShield (ASX: DRO)

DroneShield dominates Australia’s counter-drone market with over 4,000 systems sold globally. The company holds more than AUD 200 million in cash with zero debt, giving management flexibility to invest aggressively in growth.

What makes 2026 interesting is the software pivot. Management is targeting 30-40% of revenue from its SaaS platform, which could improve margins and create more predictable earnings. We believe this transition, if executed well, could support a meaningful rerating.

The catch? Valuation is stretched at roughly 28 times sales, and the stock is volatile. Shares pulled back sharply from the October 2025 high of A$6.71. For aggressive growth investors comfortable with swings, DroneShield offers pure counter-drone exposure. More conservative investors should consider waiting for a pullback.

Austal (ASX: ASB)

Austal is the lower-risk option here. The shipbuilder holds an AUD 13.1 billion order book with a 10-year horizon and delivered 503% profit growth in FY25, reaching AUD 89.7 million. Appointed as Australia’s Strategic Shipbuilder in August 2025, the company builds submarine modules for the US Navy and has 51 ships under construction.

With AUD 584 million in cash and management targeting AUD 135 million in FY26 earnings, the fundamentals look solid. In our view, Austal offers the most direct AUKUS exposure with far less volatility than peers. For investors wanting defence exposure without the wild swings, this is the pick.

Electro Optic Systems (ASX: EOS)

EOS may be the most underrated defence stock on the ASX. The directed energy weapons specialist has seen its backlog triple from AUD 136 million at the end of 2024 to over AUD 400 million today. Recent wins include an AUD 120 million South Korean laser contract and roughly AUD 180 million in new orders during December 2025.

What we find compelling is the geographic diversification; EOS is winning contracts across North America, Europe, and the Asia Pacific. Bell Potter has a price target of A$11.20, suggesting meaningful upside. For investors who believe the counter-drone theme has room to run, EOS offers better value than DroneShield.

The Investor’s Takeaway

Each stock offers a different approach. DroneShield provides the highest growth potential but comes with stretched valuations and volatility, suited for aggressive growth investors. Austal is the steady compounder with AUKUS leverage, ideal for lower-risk defence exposure. EOS sits in between, offering what looks like better value on the counter-drone and advanced weapons theme.

The defence tailwind appears structural rather than cyclical; match your risk tolerance to your pick.