Stock market

Up 125% in 27 months, can this ‘old-fashioned’ FTSE 100 stock continue its good run?

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very few. FTSE 100 Stocks that have gone up. BAE Systems (LSE:BA.) over the past two years.

Since Russia invaded Ukraine in February 2022, the company’s share price has risen 125 percent. And from May 2021 to May 2024, the defense contractor’s stock has been the index’s second-best performer.

Going against the trend

In a sense, it is a very old-fashioned company. The first army was organized in 3000 BC and, since then, companies have made money by selling weapons and military hardware.

Its shares have clearly been buoyed by the tragic events in Eastern Europe, but there is also a broader trend towards more military spending.

According to the International Institute for Strategic Studies, global defense spending will peak at $2.2 trillion in 2023.

For comparison, that’s 2.5 times where the artificial intelligence (AI) market is expected to grow in six years’ time. But very few people seem to talk about the defense sector. Instead, most prefer to focus on machine learning and large language models.

Nevertheless, I think it is worth considering NASDAQ CTA Artificial Intelligence and Robotics Index Since the start of the war in Ukraine, it has fallen by 8 percent.

Is there a danger that investors are focusing too much on the ‘next big thing’ and are ignoring other markets that are already established? In fact, I might be one of them. I have an AI fund in my ISA.

Well, the defense sector is not developing as fast as AI, but it is expanding.

And when it comes to military equipment, governments tend to ‘buy local’. BAE Systems should therefore benefit from Rishi Singh’s pledge to increase the UK’s defense budget from 2% to 2.5% of GDP by 2030. Assuming, of course, that he is re-elected.

Financial performance

At the end of 2023, the company had an order book of £58bn. This equates to 2.5 times its annual revenue.

But as the chart below shows, it has increased over the past two years. It makes me wonder if the events in Ukraine have given the company a one-time – perhaps temporary – boost.

Source: Company Annual Reports

It’s a similar story with income. It was relatively flat from 2019 to 2021, increasing by £1.2bn. However, during 2022 and 2023, sales increased by £4bn.

Source: Company Annual Reports

However, the recent rise in the company’s share price has made its stock expensive.

At the end of 2019, its shares were worth about 12 times that year’s earnings. Today, the multiple is around 22 times its profit after tax for 2023 – more than twice the FTSE 100 average.

I am sure that even the most pessimistic of observers do not think that the war will last forever. Once liquidated, I doubt BAE Systems’ revenue and earnings – and share price – will fall from their current highs.

A question of conscience

Before concluding, I think it is important to address the issue of morality and ethics. Many people would be surprised at the thought of investing in companies that provide military hardware.

However, I believe that the first duty of a democratically elected government is to protect its citizens, so I would not rule out buying defense contractor shares for my portfolio.

Nevertheless, I think BAE Systems shares are no longer offering good value and I believe there are better opportunities elsewhere.

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