Shares in FTSE 100 aerospace, defence, and security giant BAE Systems (LSE: BA) have tripled in value in 10 years.
This makes me ask a classic question (that many investors in a similar position also ask): should I buy more?
Basic buying premise still intact
I bought the stock at a considerably lower price on the basic premise that the world was becoming an ever more dangerous place. Nothing has changed to alter my view.
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The Russia-Ukraine war rumbles on, with the potential to escalate at any moment.
The Israel-Hamas War saw a dramatic escalation last week with US and UK strikes against Iran-backed Houthis in Yemen. The Houthis have vowed to retaliate imminently, which will prompt further action from the US and UK.
All the while, China watches for clues as to what the response might be to any action it takes over Taiwan. Victory on 13 January for pro-Western presidential candidate Lai Ching-te has drawn criticism from Beijing.
And Chinese President, Xi Jinping, has stated that “reunifying” China and Taiwan is a priority. Nothign has been ruled out to achieve that aim.
Clearly, no-one in their right mind wants war. However, it remains a fact that a heightened state of global insecurity benefits companies in the defence sector.
Going from strength to strength
As a global leader in this sector, BAE Systems’ results just keep getting better.
Its H1 2023 figures showed its order book increasing to £55.3bn from £42.5bn in H1 2022. Over the same period, its order backlog rose to £66.2bn from £52.7bn.
These drove sales of £12bn in H1 2023 (from £10.6bn in H1 2022), and operating profit to £1.2bn (from £1bn).
Following these results, the firm upgraded its performance guidance for full-year 2023. Sales are now expected to rise by 5%-7% (up from 3%-5%). And 2021-2023 cumulative free cashflow is predicted to increase to over £5.5bn (from over £5bn).
One risk in the shares is that those geopolitical issues markedly decline over the long term. Another is that one of its major products proves substandard and requires costly redesign.
Is there any value left in the shares?
Despite the inexorable rise in the company’s shares over 10 years, there still appears value in them.
Starting with the key price-to-earnings (P/E) ratio measurement, BAE Systems currently trades at 18.5. This is very good value when compared to its peer group valuation of 31.5. The group comprises Rolls-Royce (at 15.5), QinetiQ (17), Chemring (25.5), and Babcock International (67.9).
A discounted cash flow analysis shows the stock to be around 7% undervalued. So a fair value per share would be around £12.80, against the current £11.90.
It is a relatively low undervaluation, even if the shares reach that point. And there is no guarantee that they will, of course.
That said, the valuation is based on current figures. It obviously does not include contracts that may be signed from now onwards.
However, greed for ever greater profits and fear of losing out are the two key reasons why investors lose money, in my experience.
I already hold the stock at an excellent price, so I will stick with that. But if I did not have the shares, I would absolutely buy them now.
I think BAE Systems will remain a leader in a market that will, unfortunately, continue to grow fast.
