Smaller U.S. defense firms outpace market as demand shifts to low-cost tech

[Woman from the military team, driving the drone while using drone remote control]
miodrag ignjatovic/E+ via Getty Images

Shares of mid- and small-cap U.S. defense companies have surged this year, outstripping larger rivals as global conflicts and Pentagon priorities drive demand for cheaper, adaptable military systems such as AI-powered drones and unmanned vehicles.

The NYSE Arca Defense Index is up 34% in 2025, well ahead of the S&P 500’s 12% gain, with Kratos Defense (NASDAQ:KTOS [https://seekingalpha.com/symbol/KTOS]), AeroVironment (NASDAQ:AVAV [https://seekingalpha.com/symbol/AVAV]), Astronics (NASDAQ:ATRO [https://seekingalpha.com/symbol/ATRO]) (OTCPK:ATROB [https://seekingalpha.com/symbol/ATROB]) and Mercury Systems (NASDAQ:MRCY [https://seekingalpha.com/symbol/MRCY]) among the top performers.

The Pentagon’s proposed $892.6 billion budget for fiscal 2026 calls for nearly $6 billion in drone and counter-drone funding, almost double last year, underscoring a shift away from legacy programs like ships and fighter jets. Analysts say this trend favors firms producing modular, software-driven weapons that can be deployed quickly.

M&A and venture capital are also flowing into the sector, though deal values remain modest. U.S. aerospace and defense startups raised more than $14 billion in 2025, the highest in at least a decade, as investors bet on companies supplying next-generation systems for modern battlefields.

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