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This time five years ago, BAE Systems (LSE: BA.) shares were selling for around 520p. At the time of writing on 28 August, we’re looking at a price of 1,760p. That’s a 238% share price gain. And it would have turned a £20,000 Stocks and Shares ISA allowance into around £67,700.
It goes along with a resurgence in the aerospace and defence sector that’s seen Rolls-Royce Holdings shares soar by a huge 1,130% in the same five years.
Oh, and there’ll be a bit to add from dividends too. With BAE’s modest yield of around 2% it won’t be a lot to add. But reinvested in new shares over the five years it would help boost the effect of compound returns.
What might BAE shareholders achieve in the next five years? And with the shares having retreated 11% from their 52-week high, is this a buying opportunity?
Valuation out?
I have little doubt that BAE was undervalued a few years ago. In late 2020, its share price was barely higher than where it had been back in 2000.
But my main fear is that the current valuation might be a bit stretched, as often happens in a bullish stock recovery. The forward price-to-earnings ratio (P/E) is up at 25. It will drop to about 20 by 2027 if forecasts turn out right. But two years is a long time, and this sector has traditionally been a bit cyclical.
BAE is still some way below Rolls-Royce’s P/E of 43. So maybe on that comparison it looks cheap, but are they really comparable? Much of Rolls’ current valuation is based on the nuclear power technology behind its small modular reactors (SMRs). Demand for those looks like it could be big, and they could provide distributed power generation for the next phase of AI data centre development.
Forecasts and fundamentals
City analysts don’t share my valuation-based scepticism, it seems. There’s a strong Buy consensus out there, with an average price target of 2,075p. Such targets are usually short term, and that one would mean an 18% increase.
Something else conflicts with my caution and lends support to bullish forecasters. It’s BAE’s performance, which saw an 11% rise in sales in the first half of the year, leading to a 12% gain for underlying earnings per share.
The company’s order intake in the half dipped by £1.9bn from the same period a year ago. But still at £13.2bn, and with an order backlog of £75.4bn, BAE’s profit potential for the next few years looks attractive. It suggests confident medium-term visibility in what is typically a business with long-term contract lifecycles.
Bottom line?
So what’s my take on this? I’m torn, looking at what I rate as a very solid company that’s performing well — like it or not, defence spending is likely to remain strong for some time yet. Against that, I hesitate at the current valuation.
Do I think this is a stock worth considering for long-term growth investors? Yes, definitely. Am I thinking of buying myself? Not at today’s price, but my eyes are open for any future dips.
