One of my favourite stocks recently took the top spot for best performance over five years on the FTSE 100. Now at £13.85 per share, it’s risen 206% since May 2019, delivering an average return of 25% per year.
The company? BAE Systems (LSE: BA.)
Had I bought 1,000 shares in the stock five years ago when it cost £4.52, I’d have over £15,000 now (taking into account dividends). That’s pretty good, considering not many investments triple in only five years.
If I bought another 1,000 shares today (and the annual returns remained the same), my pot could grow to nearly £100,000 in another five years!
But there’s no guarantee it will.
The price-to-earnings (P/E) ratio of 22.9 is high and it’s overvalued by 4.3% based on future cash flow estimates. Chances are I missed out on the most lucrative growth years.
Not to worry – there’s plenty more where that came from. I’m now eyeing another UK defence stock that looks undervalued and primed for growth. Moreover, it’s caught the attention of a big-name broker lately.
QinetiQ
QinetiQ (LSE: QQ) hasn’t enjoyed anywhere near the growth of BAE Systems.
It’s up only 42% in the past five years, providing annualised returns of 7.25%. In 2022, it posted a £15m loss in operating income partly due to foreign exchange fluctuations following the $590m acquisition of US security intelligence firm Avantus Federal. After that, a few lost contract opportunities contributed to its struggles – an ongoing risk for defence contractors.
It faces fierce competition within the global defence industry and any small changes in the geopolitical risk landscape could affect its bottom line. With a market cap of barely over £2.3bn, it’s a comparatively small player in the sector. But BAE was once much smaller too too – between 2015 and 2020, BAE only grew 22%. It’s accelerated since then and today, it has a £42bn market cap.
From that perspective, QinetiQ is just getting started.
Strong results
In its 2023 preliminary full-year earnings released last week, the company revealed a 21% rise in revenue and a 20% increase in underlying operating profit. However, not everything was up. Earnings-per-share (EPS) were down from 27p to 24p and net income fell 9.6% since last year.
But with a £2.9bn backlog, orders are at a record high. Clearly, its services are in demand. And with net debt down by 25% it may be shifting focus to debt repayments over further acquisitions.
I think this could be a good short-term strategy for the company — if balanced appropriately.
My verdict?
Using a discounted cash flow model, the share price is estimated to be undervalued by 33.7% and it has a trailing P/E ratio of 16.8. The UK Aerospace and Defence industry average is about 24, so I ‘d say it’s currently trading at good value.
Overall, the financials look positive and I can understand why Shore Capital put a Buy rating on the stock last week. With a strong focus on AI-enhanced defence solutions and modern cybersecurity capabilities, I believe that QinetiQ is on the right track to a profitable future.
