Stock market

At just under £14, could BAE Systems’ share price still be a prime FTSE 100 bargain?

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BAE Systems‘ (LSE: BA) shares have more than doubled since Russia’s invasion of Ukraine on 24 February 2022. Over the past 12 months, it has rallied nearly 57 percent from its July 10 low.

This to me underscores an important point in stock investing: just because a share has gone up in value doesn’t mean it has no value left.

It may be that the company is now more capable than before. Or that the market is simply playing catch-up with the firm’s value.

In fact, in my experience, a share price can be much higher than the high share price reflects. I think this is certainly the case with BAE Systems.

Value

The UK defense company currently trades at 22.5 on a key price-to-earnings (P/E) ratio stock valuation measure.

It is therefore undervalued compared to its peers, which have an average P/E of 45.3.

The same applies to the key price-to-book (P/B) ratio. The company trades at a P/B of 4, compared to its competitors’ average of 4.7.

Hence, the shares on both key measures seem to be the same FTSE 100 deal

Business perspective

The world has apparently become a much more dangerous place since the invasion of Ukraine. The political consensus in the West is that if Russia wins its war, it will continue to push westward.

That’s why in February, NATO members pledged to increase their defense spending to 2%+ of their gross domestic product.

Germany’s IFO Institute calculated that €1.8trn would need to be spent to compensate for 30 years of underinvestment in European defence.

As much as we don’t want war, the fact is that defense companies profit from it. In the case of BAE Systems, its order book rose from £48.9bn in 2022 to £58bn in 2023. In the same period, its order backlog increased from £58.9bn to £69.8bn.

These led to sales of £25.3bn in 2023 (up from £23.3bn in 2022), and operating profit to £2.6bn (from £2.4bn).

For 2024, it expects year-over-year sales growth of 10%-12% and underlying earnings of 11%-13%.

One risk for the company is that the world becomes safer, although that is something we hope for. The other is any major redesign of the core product line, which would be very expensive.

However, consensus analyst forecasts are for annual revenue and earnings growth of 6.7% and 8.9%, respectively, through the end of 2026.

Would I buy it now?

When I turned 50, I sold almost all of my growth stocks, and bought more high-yielding stocks instead. The idea is that the dividend income will allow me to reduce my work commitments.

BAE Systems was one of a handful of development companies I hired.

It pays a dividend – currently around 2.2%. But it is less than that. FTSE 100 3.8 percent on average. And this is far below my minimum requirement for a high yield fraction of 7%.

However, one of the main reasons I kept BAE Systems was because it looked so underwhelming when I bought it – and it still does. Another important reason was that it was set for the continuous growth of the business – and the same applies today.

In short, if I didn’t already own it, I would buy it despite the recent price hike.


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