I am always on the lookout for companies with strong fundamentals within sectors that look likely to outperform the wider market. So, shares in BAE Systems (LSE: BA) have come onto my radar.
2022 was a difficult year to predict in the stock market. With so many ‘once in a generation’ happenings, it felt like every month had an event that rewrote the book on what to own.
Of course, there was no event that shocked us more than the invasion of Ukraine by Russian forces, sending oil prices and the wider commodity prices skyrocketing. This led to inflation, which central banks are still fighting to get under control.
Countries subsequently looked to strengthen their defensive capabilities, leading to a tremendous surge in the performance of companies operating in the defence sector.
BAE Systems operates across a diverse range of areas:
- Electronic Systems: navigation, controls, guidance systems and communications;
- Cyber & Intelligence: modernisation of vehicles, systems, and cybersecurity;
- Platforms & Services (US): combat vehicles, weapons, and munitions;
- Air: combat and jet aircraft manufacturing and support;
- Maritime: submarine, torpedo, radar, and naval gun systems.
How did it perform in 2022?
The FTSE 100 company saw an incredible 54% rise in 2022. Earnings have risen 13.9% annually over the last five years.
If I had invested £1,000 in BAE Systems shares this time last year, I would have a fantastic 40% return. There was also a generous dividend of 4.5% in 2022, which would give me a total of £1,445.
These returns are hardly surprising for Britain’s biggest defence company in the current “elevated threat environment”. It has a strong order book for 2023 as national and international defence spending continues to grow.
What’s next?
The key issues that hit the sector in 2022 look to have subsided. Like most companies, these were related to supply chain constraints, uncertainty around Covid, and soaring prices.
Looking ahead, the company looks to be in a healthy position. It has strong fundamentals, experienced management, and trades slightly below the sector average price-to-earnings (P/E) ratio at 18.7.
When looking at the future earnings of the company, it seems like most of the future growth has been priced into the share price. Using a discounted cash flow calculation, the shares have a fair valuation of 782p, about 7% below the current price of 837p.
This may be due to the long timeline in delivering its products, with new contract awards being the main catalyst. However, one area that may offer new opportunity is the cybersecurity area, where recent hacks of various public and private sector companies demonstrate the rising risk. If the company can look to complement its manufacturing capabilities with software systems, increased revenue that has not been priced in yet may offer some excitement for new investors.
In this uncertain market, owning a resilient, growing company with a reliable dividend of 3.3% is fair. However, with so much of the current order book priced in, and an average dividend of the FTSE 100 of 3.5%, I would suggest there are better bargains elsewhere for my portfolio.
