BAE Systems (LSE: BA.) shares have been an excellent investment. Over the last two years, they’ve nearly doubled in price.
Considering buying shares in the defence company today? I think that’s a smart move. In my view, this is a rock-solid stock with the potential for both growth and income.
Supportive backdrop
One of the first things I look for in a stock is a supportive backdrop. And we certainly have that here.
It’s unfortunate, but we live in a world today in which heightened geopolitical tension is the norm. What this means is that no government can afford to take defence and security lightly. From aircraft and submarines to cybersecurity, it needs to be a priority.
This backdrop is giving defence companies like BAE Systems a boost. For example, in mid-December, the company was awarded an $8.8bn contract by the US Department of Defense (DoD) to maintain and operate a US Army ammunition plant in Tennessee.
Meanwhile, in the last few days, Britain’s Ministry of Defence (MOD) has said it will spend £405m to upgrade a missile system used by the Royal Navy to shoot down hostile drones over the Red Sea. This is going to benefit BAE Systems too.
We do not expect an abrupt end to geopolitical conflicts in 2024, which should remain supportive of European defence spending
Deutsche Bank
Looking ahead, defence companies could get a further boost if Donald Trump wins the US election. “A Trump victory may revive discussion of a US exit from NATO and accelerate European defence investment to guarantee its safety“, wrote analysts at Deutsche Bank recently.
Top- and bottom-line growth
Looking at the financials here, the company is expected to generate revenue of £26.7bn this year, up from £21.3bn in 2022 (two-year growth of an impressive 25%).
Meanwhile, earnings per share are expected to come in at 67.7p, up from 55.5p in 2022.
So clearly, the company is growing at a healthy rate right. I always want to see solid growth when I’m looking to invest in a company. That’s because it’s a key driver of share price gains.
Valuation
Turning to the valuation, the forward-looking price-to-earnings (P/E) ratio is about 17 at today’s share price. So the stock is more expensive than it was a few years ago.
At that earnings multiple, I think there’s still potential for gains in the years ahead. I just wouldn’t expect the gains to be prolific.
It seems many City brokers share this view. Berenberg, for example, just raised its target price to 1,220p from 1,170p. That’s only about 4% higher than the current share price.
Of course, there’s also a decent dividend on offer here. Currently, the yield is about 2.7%. Given this yield, I think investors could expect to see total returns (capital gains plus dividends) of around 7-10% annually in the years ahead.
Solid returns
After the big increase in the share price over the last two years, there’s always the chance of a near-term pullback. We could see some profit taking at some point, especially if geopolitical tension eases.
Taking a longer-term view however, I think this stock is likely to provide solid returns.
