Just because BAE Systems’ (LSE: BA) share price has soared since Russia invaded Ukraine does not mean there is no value left in it.
The rise in price might simply reflect that it is worth more now than it was before. Or that the market is just playing catch-up with the value of the firm.
Indeed, in my experience, a share may be worth much more than even an elevated share price reflects. I think this applies to BAE Systems.
Are the shares undervalued?
To ascertain whether this is true, I started by looking at the key price-to-earnings (P/E) ratio stock valuation measurement.
It currently trades at a P/E of 22.4. This compares to the average P/E of its peer group of 44 – so it is very undervalued on this basis.
The same is true on the key price-to-book (P/B) ratio as well. BAE Systems trades at a P/B of just 3.9, against a peer group average of 4.6.
Therefore, on both key measures the shares still appear to offer a high degree of value.
A worsening global security backdrop
Much as none of us want it, global insecurity has dramatically increased since Russia’s 24 February 2022 invasion of Ukraine.
In response to this and other rising threats, many countries have vowed to increase their defence spending.
In February, NATO members pledged to increase theirs to 2%+ of their gross domestic product (GDP). Germany’s IFO Institute calculated that €1.8trn must be spent to compensate for 30 years of under-investment in European defence.
April saw the UK commit to spending at least 2.5% of its GDP each year on defence by 2030.
Strong business growth
One risk to the company is that the world becomes safer, although it is something we hope for. Another is any major redesign of a core product line, which would be very costly.
However, even before this new expenditure, BAE Systems’ order book ballooned to £58bn in 2023 from £48.9bn in 2022.
Over the same period, its order backlog jumped to £69.8bn from £58.9bn. These drove sales of £25.3bn in 2023 (up from £23.3bn), and operating profit to £2.6bn (from £2.4bn).
On 9 May, it said it is on track to achieve 6%-8% earnings per share growth this year on revenues 10%-12% higher.
So will I buy more?
BAE Systems is one of just a handful of growth shares that I did not sell when I turned 50 a while back.
At my stage in the investment cycle, I am focusing on shares that pay high dividends. This will allow me to increasingly live off those while further reducing my working commitments.
The defence firm does pay a dividend – currently yielding around 2.2%. So, unlike non-dividend-paying growth shares – which must be sold to realise any profit – this does provide a regular return.
However, it is nowhere near the 8.5%+ average I am making on my core high-yield holdings.
Nonetheless, given its significant undervaluation in my view, and terrific growth prospects, I will add to my holding soon.
