Is it too late to buy high-flying BAE Systems shares?

BAE Systems shares have risen more than 25% since early December. Are they still an attractive investment? Edward Sheldon takes a look.

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The last time I covered BAE Systems (LSE: BA.) shares was in January. At the time, I said that the shares had the potential to deliver both growth and income for investors.

Fast forward to today, and the share price is sitting about 10% higher than it was back then, which is a decent return in just a few months. This begs the question – is it too late to buy them?

Lofty valuation

At first glance, the shares do look quite expensive at present.

Currently, analysts expect BAE to generate earnings per share of 67.9p for 2024. So, at today’s share price of 1,283p, the forward-looking price-to-earnings (P/E) ratio is about 19.

That’s a lofty valuation for a defence company.

Defence spending boom

However, I’m starting to wonder if that kind of valuation is justified.

In recent years, it seems geopolitical tension/conflict has become the new norm. So, governments are unlikely to slow their spending on defence any time soon.

Some experts even believe that it could pick up from here. For example, analysts at JP Morgan recently noted that the European defence industry has seen 30 years of under-investment.

They believe there’s a €1.8trn gap between what was spent and what would have been spent if the NATO target of 2% spending of GDP had been met.

Today, Europe’s military capability is much diminished; it has less equipment and some of this equipment is ageing and in a poor state of repair. It will take many years of higher spending to improve Europe’s defence capabilities.

JP Morgan

As a result, they see a wave of spending on the horizon. And they reckon European defence stocks like BAE Systems have the potential for strong earnings growth and higher valuations as the visibility of earnings improves.

A high-quality business

Zooming in on BAE itself, I see it as a high-quality company.

For starters, it has a decent track record when it comes to revenue and earnings growth and a solid return on capital.

It also has an excellent long-term dividend growth track record, having raised its payout every year for over a decade. For 2023, the company raised its cash distribution by 11%.

Additionally, the company is buying back its own shares. This should help to boost earnings per share over time, making existing shares more valuable.

This kind of performance is probably worth a premium to the market.

Still worth it?

Putting this all together, I still think BAE Systems shares are worth considering as an investment.

However, if I was going to buy them, I wouldn’t go ‘all in’ at once.

Since early December, the company’s share price has risen more than 25%. After that kind of rise, there’s always the chance of a decent pullback, especially if geopolitical tension eases.

So, I’d be looking to build up a solid position in the defence company over time and average out my entry points.

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.

Edward Sheldon has no position in any of the shares mentioned. The Motley Fool UK has recommended BAE Systems. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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