I bought FTSE 100 defence giant BAE Systems (LSE: BA) stock just after Russia invaded Ukraine’s Crimea region in 2014.
Of course, I don’t advocate benefitting from tragedy. But it seemed to me that Vladimir Putin would not settle for just a nibble of a country he sees as part of Russia.
I am clearly not the only pessimist in the market. Since 2014, BAE Systems share price has tripled.
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However, as the world seems even more dangerous than it was then, should I buy more?
Is it undervalued?
Just because a stock has risen dramatically does not mean it has no value left. It may simply be that the company is worth more now than it was.
In fact, it could well be worth even more than the current share price reflects.
Even with its share price rise, BAE Systems trades on the key price-to-earnings (P/E) ratio measurement at just 20.2.
Lockheed Martin trades at 15.1, General Dynamics at 22.6, Northrup Grumman at 33.6, and RTX at 37.3.
This gives a peer group average of 27.2, against which BAE Systems’ 20.2 looks very good value indeed.
A discounted cash flow analysis reveals that the stock is around 20% undervalued. Therefore, a fair value would be around £15.50 a share, against the current £12.41.
This does not necessarily mean it will ever reach that price, of course. But it does again highlight to me that it is very good value.
There are risks in the stock, of course. One is if the world becomes significantly less dangerous over the long term, something we all actually long for. Another is that a major product proves substandard and requires costly redesign.
Strongly growing business
None of us want increased global insecurity, but that is what we have, and defence firms benefit from it.
Elevated tensions on all sides in the Russia-Ukraine and Israel-Hamas wars could escalate at any point.
And China-Taiwan tensions could ramp up too.
Against this backdrop, BAE Systems’ order book rose to £58bn in 2023 from £48.9bn in 2022.
Over the same period, its order backlog jumped to £69.8bn from £58.9bn.
These drove sales of £25.3bn in 2023 (from £23.3bn in 2022), and operating profit to £2.6bn (from £2.4bn).
For 2024, the company expects year-on-year increases in sales of 10%-12%, and in underlying earnings of 11%-13%. It also expects underlying earnings per share to increase 6%-8% over the period.
So will I buy more?
There are two key reasons for investors making losses over time, in my experience. One is greed for ever-greater profits. The other is fear of losing money, including from missing out on an opportunity.
I was fortunate enough to buy the stock at a much-reduced price compared to where it is now. So, I am happy to stick with what I have.
However, if I did not already own the stock, I would buy it now for three reasons.
First, I think the global security situation will continue to deteriorate.
Second, BAE Systems has proved that it is extremely capable of prospering in such an environment.
And third, even with the big price rise, the stock looks undervalued against its peers.
