The new paradigm of AI and software warfare has dramatically altered the finances of the defense industry
Writing: Igor Pejic
In 2011 Marc Andreessen famously declared that “software is eating the world.” Tech has indeed conquered industry after industry, not only adding new products and companies, but often rewriting the rules of competition from the ground up. Shopping, communication, financial services – the list is long. Now, software and AI are having their moment on the battlefield. The transformation of the defense sector is deep, stretching from how wars are led – with increasing quantities of autonomous war assets and the emergence of new forms of asymmetric warfare – to the financial dynamics around critical manufacturers. How defense companies make money and how investments perform has changed.
Defense corporations in the tech age
The shift away from legacy defense contractors to military technology specialists means reckoning with two key characteristics of the tech world: exponentiality and severe volatility. Uncertainty in defense tech is even larger than in the broad tech sector. The real test of a new technology or a specific product only comes once the first missiles are fired: a company that specializes in decentralized communication encryption can only find out how good its system really is when the enemy tries to break it, and a drone defense system can only truly be evaluated after thousands of enemy drones have flown over your territory. Adoption is therefore always the gold standard for assessing a technology or product, because it tells us about customer willingness to pay and about the quality of the product. Unlike with a data center or a new corporate blockchain, the quality test for defense tech might only come years after the investment decision – or never at all.
That means that diversification across multiple technologies is more critical for defense tech companies than for producers of tanks or munitions. The probability that diversified players will survive and thrive is significantly higher, as they are less vulnerable to singular failures.
Even more successful than diversified companies are those with dual-use business models. Unlike pure defense players, they have a strong commercial footprint. Data integration and analytics specialist Palantir, for example, makes 46% of its revenue with private sector customers. Even its government revenue is diversified. Beyond its military software, Palantir also helps the Department of Homeland Security keep America’s borders safe. While legacy defense contractors invariably face a slump in valuations once a war is over, dual-use companies can take their battlefield innovations and gain an edge in commercial markets. Palantir can easily apply what it has learned from its data aggregation and reasoning platform in wartime to improve decisions taken by executives in banks and hospitals.
Some legacy manufacturers like Boeing work with a dual-use model too. But it is much harder to translate experience from building a stealth bomber to a Boeing 747, than it is for a defense tech company to transfer lessons about operating a data-aggregation system. Furthermore, specializing too narrowly not only leaves a company vulnerable to changes of administration, but puts it in a much weaker negotiating position.
Solving the defense stock paradox
Not all defense tech companies are equal. The size of a company’s share of software revenue determines the impact of the new rules of the tech world upon it.
The new paradigm of AI and software warfare has altered battlefield economics dramatically. For the first time in history, the restrictions of the physical world no longer apply. From swords and spears to tanks and submarines, the outbreak of wars has always meant a period when supply is unable to keep up with demand. This is why most defense stocks underperform in times of war – something dubbed the defense stock paradox.
Yet defense tech companies have solved this paradox. For software, there are no scaling limitations. A server might need to be added here and there, but marginal costs are close to zero. The more people and machines use a software, the better the business case. Thus, the bigger the software revenue share, and the more compatible a software is with multiple hardware models, the lower the supply constraints.
Indeed, defense tech companies are not just immune to the defense stock paradox – they may exacerbate it for legacy suppliers. The software age has given rise to powerful tools that enable asymmetric warfare on a new level. Relatively cheap drones can wreak havoc on critical infrastructure and destroy traditional – expensive – war assets like tanks and fighter jets, thus exacerbating the mismatch of supply and demand.
The new logic of commercial success
The software age has upended the financial profile of a typical defense company. A much-loved metric among investors is the price-to-earnings (P/E) ratio, because it measures the value of a company by its profitability.
Warren Buffett reportedly once said he was looking for companies with a P/E ratio below 15; everything above was too expensive for him. Today’s technology sector is different, however. Most big tech companies have P/E ratios above 30 – yet they are among the best-performing equities of recent years. And defense tech often goes much higher. Palantir has a trailing P/E ratio of above 220 (down from more than 450 in 2025).
Another significant difference with traditional contractors like Lockheed Martin is that for the new generation of defense tech firms, margins are secondary. Of course, it is a big advantage if a company is profitable, especially because the free cash flow makes future investment in innovation cheaper. Yet most companies with a steep growth curve are unprofitable. The widely-hyped drone weapons manufacturer Anduril does not expect to turn a profit until 2030 – yet investors have accepted that prospect, because the company expects to double its revenue in 2026. The value of other defense tech companies is reflected in similar growth metrics.
Technology has remade the defense sector on every possible level, including the financial. Understanding the industry’s new logic isn’t only vital for generals. Managers, governmental purchasers and investors alike can no longer think in terms of the common wisdom built during a now-obsolete industrial war paradigm. The defense industry is an object lesson in the power of technology to disrupt long-established business models.
Igor Pejic is a keynote speaker, banker and author of Tech Money: A Guide to the New Game of Technology Investing (Diversion Books)
