BAE Systems’ (LSE: BA) share price has risen over 40% in the last 12 months. And over the last 10 years, shares in the aerospace, defence, and security giant have nearly tripled in price.
Increases like this raise an important question for investors: can there be any value left in such a stock?
In my view, this comes down to two key factors. First, whether the business grows strongly from here. And second, how the company’s share price looks relative to its competitors.
Can the business grow strongly?
No-one wants increasing global insecurity, but that is the current situation and defence firms benefit from it.
And far from becoming less dangerous, I think the world will become even more so in the coming years.
The Russia-Ukraine conflict looks set to continue indefinitely. US and UK military strikes against Iran-backed proxy militias in the Middle East have escalated tensions there.
And CIA Director William Burns said on 26 February last year that China’s President Xi Jinping had ordered the military to “be ready by 2027” to invade Taiwan.
Against this increasing insecurity, BAE Systems’ order book in H1 2023 rose to £55.3bn from £42.5bn in H1 2022. Over the same period, its order backlog jumped to £66.2bn from £52.7bn.
These drove sales of £12bn in H1 2023 (from £10.6bn in H1 2022), and operating profit to £1.2bn (from £1bn).
How does the stock look against its competitors?
A sharp rise in a company’s share price does not necessarily mean it is overvalued. It may simply be that the company is worth more now than it was before.
In fact, it could well be worth even more than the current share price reflects.
To find out whether this is true for BAE Systems, I looked at the key price-to-earnings (P/E) ratio measurement.
BAE Systems currently trades at 18.2. This is very good value when compared to its peer group valuation of 32.3.
The group comprises Rolls-Royce (at 15.7), QinetiQ (18.8), Chemring (25.5), and Babcock International (69.1).
A discounted cash flow analysis shows the stock to be around 27% undervalued. So a fair value would be around £16.15 a share, against the present £11.79.
This does not mean that the shares will ever reach that price. But it does underline to me that there is still very good value left in them.
There are risks in the shares, of course. One is if the world becomes a lot less dangerous over the long term. Another is that a major product proves substandard and requires costly redesign.
Too late for me to buy more?
Provided that I can see value remaining in a stock, it is never too late for me to buy it. Investing for the long term allows a company time to realise this value.
As I see such value in BAE Systems, I am seriously considering buying more.
An additional benefit in my view is that it also offers a yield. Currently, it is only around 2.4%, compared to the present FTSE 100 average of 3.8%. However, the company has paid much more in the past and it might do so again.
This means any share price gains can be seen as an added benefit on top of a basic return.
