This FTSE 250 defence stock looks nearly 50% undervalued against its peers to me

I think this FTSE 250 firm looks very undervalued, especially with a big and growing order book, and a massive new contract just signed with the MoD.

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I’d buy FTSE 250 defence firm QinetiQ (LSE: QQ) today if I was starting on my investment journey.

I think it has all the qualities that make a great growth stock over time. It also pays a dividend, which currently yields 2.2%. That’s a bonus, in my view.

As it is, I turned 50 a while back, so am focusing on maximising my passive income through high-dividend-paying stocks.

I still own a handful of growth shares, including defence giant BAE Systems (LSE: BA). It’s gained around 120% since Russia invaded Ukraine on 24 February 2022. And it’s up over 30% in the last 12 months alone.

One thing I learned as an investment bank trader was to look at the next rung down in a high-performing sector. The top-flight FTSE 100’s defence firms have already seen big gains since 2022. And they may well see more.

But it’s in the next level – the FTSE 250 – that we’re likely to see tomorrow’s star defence growth stocks.

Founded by the MoD

QinetiQ isn’t some fly-by-night brainchild of a Silicon Valley technology geek.

It was founded in July 2001, when the UK’sMinistry of Defence (MoD) split its Defence Evaluation and Research Agency in two. The smaller portion was rebranded as the Defence Science & Technology Laboratory, and the bigger portion became QinetiQ.

In 2003, it signed a 25-year agreement to provide the MoD with testing and evaluation technology for military and civilian use.

It also provides such services to other institutions and companies, including in the US through its Avantus operation.

Is the business growing strongly?

One risk with defence stocks (and QinetiQ is no different) is a failure in any of its key products. These can prove very costly in time and money. Another is that the world suddenly becomes a much safer place, a problem for the stock despite us all wanting this.

However, a Q3 trading update on 16 January showed year-to-date orders of around £1.35bn. The US Avantus operation won $872m of new contracts over that period.

QinetiQ’s order backlog was £3.13bn at that point – up from around £2.97bn in the same period the previous year.

Overall, the firm said it’s on track to deliver full-year 2024 revenue of £1.871bn and an operating profit of £210m. This compares to 2023’s £1.58bn revenue and £153m operating profit.

Since that update, 5 March saw it announce it had won a key supplier role for the MoD’s £1.2bn Digital and IT Professional Services framework.

Overall, following seven years of growth, QinetiQ intends to approximately double its revenues — to £3bn — over the next four years.

Nearly 50% undervalued?

On the key price-to-earnings (P/E) stock valuation measurement, QinetiQ trades at 18.5 against a peer group average of 34.2. This looks very undervalued to me.

But by how much? A discounted cash flow analysis using other analysts’ cash flow forecasts and my own shows it to be around 46% undervalued at its current price of £3.50.

Therefore, a fair price would be about £6.48 a share. This doesn’t necessarily mean that it will ever reach that price, but it confirms to me that it looks very good value.

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.

Simon Watkins has positions in BAE Systems. The Motley Fool UK has recommended BAE Systems and QinetiQ Group Plc. 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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