Defense shares BAE systems (LSE:BA.) i International Babcock (LSE:BAB) gained strength FTSE100 today (July 21). As I write, they are up 0.8% and 4% respectively.

The catalyst was the election of novel Prime Minister Andy Burnham as Chancellor of the Exchequer, John Healey. He resigned as defense minister last month after a row over military spending.

Therefore, his nomination is interpreted as a bullish signal for future defense spending. Let’s unpack what’s going on here.

Background

As a reminder, Healey was quite scathing in his resignation letter. He wrote that the previous government was “they are unwilling to commit the resources the nation needs to defend the country in a time of growing threats“Oh.

While Starmer agreed to a NATO commitment to achieve 3.5% of GDP on defense by 2035, Healey argued that to realistically achieve this, the UK needs an interim target of 3% of GDP by 2030. This is what most European allies are doing.

However, he said the novel Defense Investment Plan does not meet this requirement, meaning they will spend just 2.68% by 2030, a slight raise from 2.6% in 2027.

Why such a discrepancy in shares?

Essentially, Healey argues that additional spending should be focused upfront to address immediate threats from Russia. And now that it has influence, the stock market reacts in a similar way.

However, as mentioned, Babcock is much better than BAE. This is because it would likely benefit more from faster UK defense spending. More than 70% of the company’s revenue last year came from the UK, compared with just 28% for BAE.

However, this is one of the reasons I prefer BAE and have the money – it has much greater geographic diversification. In particular, the defense giant gets a significant portion of its sales (almost half) from the United States, where the military budget appears set to overshoot, at least if Donald Trump has his way.

By comparison, last year less than 5% of Babcock’s sales came from North America.

BAE also has a higher dividend yield of 2.2% compared to Babcock’s 1.2%. And while the company’s stock forward price-to-earnings (P/E) ratio of 21 is higher than Babcock’s ratio of 16, it reflects a significantly larger order backlog and higher operating margins.

Mega-projects

In other news today, it was announced that Canada will join the Global Combat Aviation Program (GCAP) as an observer nation. This could be a springboard for her to join the three founding members (UK, Italy, Japan) who are building a next-generation stealth fighter.

Rolls-Royce believes this novel jet has greater export potential than the Eurofighter Typhoon. BAE is involved in these kinds of megaprojects, which is another reason I’m bullish on the stock in the long term.

Is Babcock worth watching?

Shares in both companies could fall sharply if there is news that higher military spending in the UK and Europe is at risk.

Furthermore, as a BAE shareholder, I am in the strange ethical position of wanting the war in Ukraine to end while simultaneously acknowledging that doing so may cause the stock price to decline in the brief term. I understand that defense stocks are not for everyone.

That said, I don’t think ending the war in Ukraine would erase the long-standing government commitments that underpin the company’s true value.

So I think BAE, and potentially Babcock, could be worth considering buying today.

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Ben McPoland owns shares in BAE Systems and Rolls-Royce.