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Is BAE Systems plc Still A Buy After The 2013 FTSE Bull Run?

2013 has been the year in which even the most hardened stock market bears have admitted that we’re in a five-year bull market — and it’s not over yet.

Although the FTSE 100 has slipped back from the five-year high of 6,875 it reached in May, it is still up 8% this year, and is 51% higher than it was five years ago. As Christmas approaches, I’ve been asking whether popular stocks like BAE Systems (LSE: BA) (NASDAQOTH: BAESY.US) still offer good value, after five years of market gains.

Back to basics

BAE’s share price has climbed 28% this year, outperforming the FTSE by a large margin — but it’s only up by 25% over the last five years, thanks to a long period in the doldrums from 2009 until early 2012.

However, billionaire investor Warren Buffett says that one of the most important lessons he learned from value investing pioneer Ben Graham, is that “price is what you pay, value is what you get”.

Do BAE shares still offer good value, or has this year’s rapid rise left them looking expensive?

Ratio Value
Trailing twelve month P/E 11.1
Trailing dividend yield 4.7%
Operating margin 9.0%
Net gearing 28%
Price to book ratio 3.3

On these figures, BAE continues to look reasonably priced. The firm’s debt levels are low, and its 4.7% dividend yield remains very attractive, although dividend growth has slowed to around 3% per year over the last couple of years.

Outperform the FTSE in 2014?

Failure to resolve BAE’s long-running Salam Typhoon contract dispute in 2013 will dent the firm’s profits, but shouldn’t be a massive problem. What I hope to see in 2014, however, is continued growth in BAE’s non-UK and US order intake, in addition to signs that defence spending is stabilising in the UK and US.

Analysts are expecting a fairly flat performance in 2014, with current consensus forecasts showing a marginal drop in earnings per share compared to 2013 forecasts:

2014 Forecasts Value
Price to earnings (P/E) 10.0
Dividend yield 4.9%
Earnings per share growth -3.2%

If BAE manages to deliver a satisfactory resolution to the Salam Typhoon dispute, and can reassure investors that US and UK defence spending is unlikely to be cut further, then I believe that the BAE’s share price could outperform the market in 2014, as it continues to look very cheap.

I hold BAE shares in my retirement portfolio, as I value their high yield, and believe that in the long term, defence spending is likely to remain a very significant proportion of UK and US government budgets.

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> Roland owns shares in BAE Systems.