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The BAE Systems (LSE:BA.) share price is just off all-time highs. It’s now a £61bn company, making it one of the largest defence contractors outside of the US.
However, that’s not overly important for investors. Or it shouldn’t be.
The focus for all investments must start with the valuation. Let’s have a closer look and explore what analysts think will happen over the next 12 months.
Valuation is always the starting point
BAE’s current valuation reflects a premium multiple relative to historical earnings. This has been supported by steady earnings growth and a solid balance sheet.
The reported price-to-earnings (P/E) ratio has moderated from 31.9 times in 2024 to around 24.2 times on a forward basis for the coming 12 months.
Adjusting for expected earnings growth, the price-to-earnings-to-growth (PEG) ratio sits near 2.2 times, indicating that expectations for future growth are embedded in the valuation.
Typically a PEG ratio over one suggests an overvalued position, but it’s all relative to the sector, balance sheet and the dividend yield, as well as expected buybacks etc.
Net debt has fluctuated over recent years, rising to £6.98bn from £2.26bn in 2023, which suggests a higher leverage profile. However, this undoubtedly reflects higher investments in production, as well as R&D, since the start of the war in Ukraine.
Dividend growth has been strong in recent years, growing from 25.1p per share in 2021 to 39.7p per share for the coming year. Looking forward the yield sits around 2.1%. Nothing huge, but always worth noting.
What do analysts think?
Analysts are split on BAE Systems. There is one Strong Sell, two Sells, three Holds, nine Buys, and six Strong Buys. However, the average price target is only 1% above the current share price. That does suggest that the stock is trading very close to fair value.
I broadly agree. I think the stock is expensive on a growth-adjusted basis, however, this is a sector where companies have relatively predictable cash flows and strong government-backed order books, which can justify higher multiples compared with more cyclical sectors.
What’s more, it’s not unrealistic to assume there will be more catalysts on the way. Beyond gloomily hypothesising where geopolitical tensions will rise next, it’s worth thinking about BAE’s space capabilities.
These capabilities position the company to benefit from growing investment in space industries including communications, but also data centres.
One concern, however, is that near-term earnings projects haven’t been increasing. They’ve been flat for some time. That’s not unsurprising, it’s just disappointing. Essentially, the value is in the order book and long-term commitments to defence programmes.
I believe BAE is worth considering. However, I’d suggest there are better investments in the same sector. For example, I picked up shares in Innovative Aerosystems in November. They were great value, and were up 150% in the last two months.
Clearly those shares aren’t as cheap as they were. But it goes to show, if you look hard enough, we can still find value in this buoyant sector.
