Why BAE Systems plc Should Be A Winner This Year

2014 should be a good year for BAE Systems plc (LON: BA).

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BAE Systems (LSE: BA) (NASDAQOTH: BAESY.US) gets my attention today, in my examination of the prospects for some of our top FTSE 100 companies in 2014.

Let’s start with a look at BAE’s performance over the past five years, with the latest consensus forecasts for this year and next:

Dec Pre-tax EPS Change Dividend Change Yield Cover
2008 £2,371m 37.1p +23% 14.5p   3.8% 2.6x
2009 £266m 40.1p +8% 16.0p +10% 4.5% 2.5x
2010 £1,409m 39.8p -1% 17.5p +9% 5.3% 2.3x
2011 £1,466m 45.6p +15% 18.8p +7% 6.6% 2.4x
2012 £1,369m 38.9p -15% 19.5p +4% 5.8% 2.0x
2013(f) £1,371m 42.7p +10% 20.3p +4% 4.6% 2.1x
2014(f) £1,348m 42.0p -2% 20.9p +3% 4.8% 2.0x

An erratic few years

We see a bit of a crunch in 2009, but with payments for major contracts being irregular in the aerospace and defence business, profits on a year-by-year can be volatile. And by maintaining strong cover, BAE has been able to keep its dividends going nicely ahead of the FTSE’s average of around 3%.

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Those 2013 forecasts were looking reasonably safe at the time of BAE’s third-quarter update in October, which told us that “Trading for the period has been consistent with management expectations at the time of the half-year results announcement on 1 August and the outlook remains unchanged“.

But since then, a hoped-for deal with the United Arab Emirates has fallen through, and a failure to agree pricing for a Typhoon contract with Saudi Arabia is set to knock 6-7p off EPS. So instead of that forecast 10% rise in EPS, we could be seeing a small fall instead.

But it’s really more of a delay than a loss, and I can’t see any long-term harm coming from it.

The share price

The BAE share price has performed poorly over the last five years, gaining only around 10% while the FTSE 100 has put on 45%. But over the past year, the picture is looking a bit better, with BAE shares up 22% compared to 12% for the FTSE.

But even after the gains of the past 12 months, BAE shares are still on a forward P/E based on 2014 forecasts of only 10, which is quite a bit below the FTSE average of around 14. Cheap? I think so.

At the end of 2011, when the shares were around their bottom, BAE’s P/E stood at an almost unbelievably low 6.3 even though that dividend stream was still flowing strong. Do you wish you’d bought some then? I wasn’t running the Fool’s Beginners’ Portfolio at the time, but I did add BAE Systems to it on October 2012 at a price of 332p — and we’ve seen a 30% gain since then.

Further to go?

At current valuations, I really can’t see BAE having anything but a positive 2014, and I’d be very surprised not to see that P/E strengthening over the year with a decent share price rise.

Verdict: Climbing higher in 2014

But here’s another bargain investment that looks absurdly dirt-cheap:

Like buying £1 for 31p

This seems ridiculous, but we almost never see shares looking this cheap. Yet this Share Advisor pick has a price/book ratio of 0.31. In plain English, this means that investors effectively get in on a business that holds £1 of assets for every 31p they invest!

Of course, this is the stock market where money is always at risk — these valuations can change and there are no guarantees. But some risks are a LOT more interesting than others, and at The Motley Fool we believe this company is amongst them.

What’s more, it currently boasts a stellar dividend yield of around 10%, and right now it’s possible for investors to jump aboard at near-historic lows. Want to get the name for yourself?

See the full investment case

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

> Alan does not own shares in Royal Dutch Shell or BP.

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