When the federal government spends on areas like defense and healthcare, the money doesn’t just flow to its attached agencies.

Funding ends up getting funneled to government contractors and other service providers too. With spending on the rise over the past few years, contractors like Leidos (LDOS) have benefitted from this windfall.

Leidos is a solutions provider specializing in defense, aviation, information technology, and scientific and medical research.

In recent years, the company has delivered above-average returns due to the breadth and scope of its services and its status as a mission-critical solutions provider.

That said, investors are forecasting a decline in the company’s returns.

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Federal spending has risen considerably over the past several years, growing from $5 trillion in FY 2016 to $7 trillion in FY 2025. And throughout this period, funds have consistently flowed into social security, healthcare, and national defense.

Most recently, national defense has been given increasing attention. Due to an increasingly complex geopolitical environment, America’s defense spending has risen from roughly $705 billion in FY 2021 to $961 billion in FY 2026. For FY 2027, that figure could rise even further to $1.5 trillion provided the White House’s defense budget proposal is approved.

When the federal government spends on areas like defense, the money it distributes doesn’t just flow to its agencies, they also reach government contractors and other service providers.

And with the defense budget rising in recent years, Leidos (LDOS), a defense, aviation, information technology, and biomedical research provider, has benefitted immensely.

Leidos currently operates four business segments: National Security & Digital, Health & Civil, Commercial & International, and Defense Systems. 

National Security & Digital specializes in providing IT, cyber, software and intelligence support to federal government clients. Meanwhile, Health & Civil focuses on health care coordination, health management software, energy and environment solutions, transport solutions, and life science and development research.

Defense Systems on the other hand, provides mission-critical airborne, maritime, aerospace, and land systems support and solutions to various defense and intelligence agencies. Commercial & International provides energy and critical infrastructure support to companies and foreign government agencies.

Of the four segments, National Security & Digital brings in the lion’s share of Leidos’ revenue at 44% as of FY 2025, followed by Health & Civil at 30%, then Commercial and Defense System at 13% each. 

Leidos derives its revenue mostly from its prime contracts with the U.S. government’s various branches, such as its intelligence agencies, the U.S. Army, Navy, and Airforce, the Department of Health and Human Services, and others.

It also operates a relatively asset-light business, since most of its expenditures revolve around human capital. Non-labor expenditures are mostly limited to IT equipment, software, and the likes. 

Leidos recently won contracts from the U.S. Army (worth $2.7 billion), the State Department, and the Pentagon. 

The company’s client base and asset-light status has helped it deliver above-average returns over the past few years. Last year, it delivered a Uniform return on assets (“ROA”) of 37%, triple the corporate average, alongside an asset growth of 10%.

That said, Leidos currently trades at a below-average P/E of 10x, with this valuation signaling a significant dip in returns.

We can see this through Valens’ Embedded Expectations Analysis (“EEA”) framework.

The EEA starts by looking at a company’s current stock price. From there, we can calculate what the market expects from the company’s future cash flows. We then compare that with our own cash-flow projections.

In other words, the EEA shows how well a company has to perform in the future to be worth what the market is paying for it today.

At current valuations, investors expect Leidos’ Uniform ROA to decline to 14% by 2030, well below its five-year average Uniform ROA of 35%.