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BAE Systems’ (LSE: BA) share price has dropped 9% from its 3 October one-year traded high of £20.71.
I think part of this is due to profit-taking on the extended bullish run since Russia invaded Ukraine on 24 February 2022. It has jumped 213% since that point.
The other part is due, I believe, to the market’s view that the global security situation has eased. This follows the ceasefire agreement between Israel and Hamas that came into effect on 10 October. It also reflects ongoing efforts by US President Donald Trump to catalyse a ceasefire in the Russia-Ukraine War.
Given both factors, I think now might be the right time for me to buy more shares in the firm.
On a technical basis, the price drop may have added to any existing price undervaluation to ‘fair value’. So, I need to look at this in depth.
On a fundamental basis, I do not think that the global situation has eased at all. The Israel-Hamas ceasefire looks tenuous to me. And Russian President Vladimir Putin has shown no genuine commitment to peace, in my view.
Even if the global security situation does ease, NATO countries are still committed to raising their defence expenditure. Specifically, this will see a rise from 2024’s average of 2% of gross domestic product to 5% by 2035 at the latest.
As the world’s sixth-largest defence firm by revenue and Europe’s largest, BAE Systems should benefit enormously from this.
First things first – the price/value gap
To cut to the chase on whether there is any value left in its shares, I use the discounted cash flow (DCF) model. This identifies exactly where a stock should be trading, based on cash flow forecasts for the underlying business.
The additional benefit of this method is that it produces a ‘clean’ standalone valuation. That is, it remains unaffected by any under- or over-valuations present across the sector in which a firm operates.
In BAE Systems’ case, the DCF shows that the shares are 26% undervalued at their current £18.76 price.
Therefore, their fair value is £25.70.
This price/valuation gap is crucial because asset prices tend to converge to their fair value over time, in my experience. This includes several years as a senior investment bank trader and decades as a private investor.
Consequently, they look sufficiently like a bargain for me to re-examine the business.
The firm’s fundamentals
The key to increases is any firm’s share price (and dividends) is earnings (or profits) growth.
A risk here is any malfunction in its products, which could be costly to fix and damage its reputation.
However, consensus analysts’ forecasts are that BAE Systems’ earnings will grow by a strong 11.3% to end-2027.
This looks well supported to me by recent results. 30 July’s H1 2025 numbers saw earnings before interest and tax (EBIT) rise 13% year on year to £1.55bn as sales rose 11% to £14.621bn.
Consequently, the firm upgraded its sales guidance for the full year to 8%-10%, from 7%-9%. It also upgraded its underlying EBIT guidance to 9%-11%, from 8%-10%.
Given its bargain valuation and strong earnings growth prospects, I will buy more of the stock at the earliest opportunity.
