As BAE Systems’ share price drops 5%, is it time for me to buy the dip?

BAE Systems’ share price has fallen, making it look more undervalued to me than before, supported by a strong order book and earnings prospects.

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BAE Systems’ (LSE: BA) share price has dropped 5% from its 3 June 12-month traded high of £13.99.

Much of this has been due to investors taking profit following a 37% rise from its one-year traded low of £9.68, I think. And since the onset of the Russia-Ukraine War on 24 February 2022, the stock has jumped 119%.

That said, the best results from stock investment come from taking a long-term view, in my opinion. And on this basis, any notable dip in BAE Systems shares looks like a buying opportunity to me.

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The world is becoming more dangerous  

The recent escalation in violence between Israel and Iran threatens a broader Middle East conflict, in my view.

There also remains no sign of an end to the Russia-Ukraine War. And China’s President Xi Jinping last year told his military to deepen war and combat planning.

Much as none of us want to see further conflicts, increasing global insecurity benefits defence firms. And many countries in Europe and Asia believe that building up their defences will deter future wars.

NATO members, for example, have now committed to increase their annual defence spending to 2%+ of gross domestic product.

Globally, defence spending hit a record $2.4trn last year.

Ideally placed to secure new spending

As the largest defence contractor in Europe and the seventh-largest in the world, BAE Systems looks well-placed to benefit.

It has already done so, with its H1 2024 results showing a £1.6bn increase in its order book over the six months, to £59.6bn. Its order backlog jumped £4.3bn over the period to £74.1bn.

This powered a 13% rise in sales to £13.399bn. Operating profit over the period increased 5% to £1.296bn.

Since the release of the results on 1 August, more big orders have rolled in. Only the next day, it received a $493m contract from the US Army.

On 6 August, it was awarded a $48m contract from the Air Force Research Laboratory. And on 20 August, it was selected by Boeing to upgrade the flight control computers for its Eagle and Super Hornet fighter planes.

I see the principal risk for the firm being that any of its major products fail. This could be costly to repair and dent the company’s reputation.

However, analysts forecast earnings growth of 7.3% a year to end-2026. And earnings per share are expected to grow 9% a year to then.

Is there value left in the shares?

Despite the surge in BAE Systems’ share price since February 2022, they still have substantial value in them, I believe.

On the key price-to-earnings (P/E) measure of stock value, the shares trade at just 21.5 against a peer average of 43.1. This looks very cheap.

To find out how cheap they are in cash terms, I ran a discounted cash flow analysis. This shows the shares to be 21% undervalued at their present price of £13.23. So a fair value for them would be £16.75, although they may go lower or higher than that.

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I have been adding BAE Systems shares on dips for several years now and will do so again very shortly.

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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.

Simon Watkins has positions in BAE Systems. The Motley Fool UK has recommended BAE Systems. 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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