Here’s how much I’d have if I’d bought 1,000 shares in this FTSE 100 defence stock 5 years ago

I could have made a pretty penny investing in this leading FTSE 100 defence stock. Now I’m looking at a smaller company I think has similar potential.

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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.

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.

Mark Hartley has positions in BAE Systems and QinetiQ Group Plc. 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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