BAE Systems vs Rolls-Royce: which are the best shares to buy today?

Edward Sheldon compares shares in BAE Systems with those in Rolls-Royce. Which are cheaper? And which offer the better dividend yield?

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Shares in both BAE Systems (LSE: BA.) and Rolls-Royce (LSE: RR.) have performed really well. Over the last three years, they’re up about 150% and 350% respectively.

Wondering which shares are looking most attractive today? Here’s my take.

Looking at the big picture

Let’s start with some big picture analysis here. BAE Systems is mainly a defence company. By contrast, Rolls-Royce is an aerospace company that also generates revenues from defence and power systems.

Given the industries they operate in, I think both have bright prospects in the medium to long term. Where Rolls-Royce possibly has the edge though is its diversified business model.

If there was a major slowdown in defence spending, BAE Systems’ revenues could be impacted significantly. However, if there was a big slowdown in civil aviation, Rolls-Royce’s other divisions may provide a buffer.

Who’s performing better?

Both companies are doing really well today. BAE Systems is benefitting from the defence spending boom. Meanwhile, Rolls-Royce is enjoying tailwinds from a strong travel industry.

In terms of revenue, BAE Systems is forecast to generate growth of 22% this year versus 9% for Rolls-Royce. But in BAE’s case, we need to strip out the acquisition of Ball Aerospace. Doing that, I get growth of around 13-14% for the company. So it still wins here.

As for earnings per share, both companies are expected to generate growth of around 11% this year. Again though, BAE Systems will get a boost from its acquisition, meaning Rolls-Royce has the stronger earnings growth.

So overall, it’s a little hard to call a winner here.

Which stock is cheapest?

Looking at valuation, the defence company’s the clear winner on this front. Today, both companies have market capitalisations of around £40bn.

But here’s the thing – BAE Systems currently trades on a forward-looking price-to-earnings (P/E) ratio of 19 while Rolls-Royce is on 30.

I can justify a ratio of 19 for BAE Systems. I find it hard to justify a P/E ratio of 30 for Rolls-Royce though. That multiple looks a little stretched to me. At that valuation, I’d expect the shares to be volatile if there was any bad news. It’s worth noting that they’re down significantly today (25 June) after Airbus issued a profit warning.

BAE Systems is cheaper on a free cash flow yield basis too. Its multiple here, using trailing free cash flow per share, is about 6.8%. That compares to 4.5% for Rolls-Royce.

Who has the best dividend yield?

Finally, let’s look at dividends. Now, BAE Systems’ a very reliable dividend payer and the yield right now is about 2.4%.

Rolls-Royce however, hasn’t paid a dividend for years. Analysts do expect a small payout this year. But the yield’s likely to be under 1%.

So BAE wins here.

The winner

Putting this all together, the winner for me is BAE Systems. It’s the stock I’d buy today if I was looking to snap up one of these blue-chip industrial stocks for my portfolio.

Of course, there’s no guarantee it will outperform Rolls-Royce in the years ahead. I’d just be more comfortable buying it today given its lower valuation and higher dividend yield.

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.

Edward Sheldon has no position in any of the shares mentioned. The Motley Fool UK has recommended BAE Systems and Rolls-Royce 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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