What’s going on with the BAE share price?

The BAE share price has started going into reverse in recent days. Dr James Fox explores what’s next for this defence contractor.

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The BAE (LSE:BA.) share price has surged over 12 months. It’s been one of the FTSE 100‘s best-performing stocks, up 26.2% over 12 months, 71.7% over two years, and 147.7% over three years.

However, there are concerns that BAE stock, and its European peers, have extended too Far. On Tuesday 9 April, Europe’s defence and aerospace stocks suffered a £12bn sell-off.

Let’s take a closer look at BAE Systems.

Average target price

Often, when I’m trying assess the value of a stock, the first place I look is the share price target. This is created by taking an average of all the share price targets issued by City and Wall Street analysts over 12 or three months. Obviously, younger share price targets can be more relevant.

The average price target for BAE Systems is £13.53. That represents a 5.93% premium versus the current price. Naturally, we want to see a stock trading at a discount to the target price. But there’s not a huge margin here. It’s also worth highlighting that UK stocks don’t tend to trade too close to their price targets because investor sentiment is generally pretty poor.

Nonetheless, BAE has eight Buy ratings, three Outperform ratings, six Hold ratings and one Underperform.

Defence stocks overheating

European defence stocks have done something unimaginable over the past two years, and that’s closing the valuation gap with their US peers. For context, while BAE is up 71.7% over two years, RTX Corp (formerly Raytheon) is up just 13% over the period.

Of course, a major reason for this is that there’s a war in Europe and not North America. Russia’s moves have led to an increase in defence spending among countries that previously shied away from their 2% NATO commitments.

However, analysts have raised concerns that European defence stocks are now getting too expensive. That explains 2 April’s sell-off.

I’d also imagine that David Cameron meeting Donald Trump had something to do with the pullback. The visit might have been in line with protocol, but it sounds like European powers won’t be able to stop Trump from forcing through a peace deal if he becomes President again. In turn, this would stop the war and potentially slow defence spending.

The bottom line

In the end, it all comes down to valuations. Here’s how BAE stacks up against it peers.

P/EBAERTXLockheed MartinNorthrop Grumman
202419.818.817.218.5
202517.716.616.216.5
202616.214.915.515.5

In the above table, I’ve used projected earnings for these four defence contractors and have created forward price-to-earnings ratios accordingly. As we can see, BAE Systems looks more expensive than its US peers.

BAE isn’t wildly expensive, but it has certainly closed the valuation gap with its American peers. There’s no obvious answer as to whether BAE is overvalued. It’s growing faster than its peers, but it’s a little pricier.

And would an end to the war slow defence spending in Europe? Probably, but not for a while. Defence spending is already locked in.

BAE is certainly a stock worth considering. I’ve been keeping my eye on it for some time. But I’m not buying for now.

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.

James Fox has no position in any of the shares mentioned. The Motley Fool UK has recommended BAE Systems and Lockheed Martin. 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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