Anyone who had the skill or good fortune to invest in BAE Systems (LSE: BA) shares in recent times will have done very well indeed. A stake acquired five years ago would be up by over 250%. Even those buying at the start of 2025 will have enjoyed a gain five times that of the FTSE 100 index over the same period.
For this reason, it was perhaps only natural that today’s half-year report from the defence titan would garner a lot of attention.
The reaction has been… interesting, to say the least.
Beating expectations and raising guidance
Reflecting the tense geopolitical climate and increased military spending, BAE announced that sales had climbed to £14.6bn in the first half of the year. This was up from the £13.4bn achieved in H1 2024. It also surpassed analyst estimates of £14.5bn with all parts of the business seeing growth. Adjusted earnings of £1.55bn beat projections too.
But the good news didn’t stop there. Looking ahead, BAE said that it would be upgrading its annual underlying earnings forecast. This was now expected to be 9% to 11% higher than in 2024. Growth of between 8% and 10% had previously been anticipated.
Not cheap
Now, one would think a positive update like this would go down well. But this hasn’t happened. As I type, the BAE share price is down.
My theory is that a lot of this is due to the valuation looking pretty rich before the results were announced.
Based on analyst estimates, the stock traded at a forecast price-to-earnings (P/E) ratio of 24 as the market opened. That’s arguably the sort of number usually reserved for smaller growth stocks, not £55bn stock market juggernauts.
This valuation is also significantly higher than BAE’s average P/E over the last five years. I can remember a time when the very same stock traded on less than 10 times earnings!
Risks ahead
To be clear, a slight slip in the price on results day does not mean the shares are about to crash. However, it does at least suggest that additional price rises might be harder to obtain. Any future hiccup — from contract delays to technical difficulties — could be punished by the market.
Resolutions to the conflicts in the Middle East and Ukraine, while great from a humanitarian perspective, could make investors believe that the earnings purple patch is over too.
BAE is also heavily dependent on only a few countries for sales, particularly the US.
Don’t bet the house
Then again, there’s no shortage of bad actors in this world. The need for nations to protect their citizens from outside threats will never go away completely. For this reason, I continue to regard BAE Systems as a great option for long-term investors to consider.
On a more fundamental level, this company has shown itself adept at generating lots of free cash flow, leading to higher dividend payments every year. While the yield is now just 2%, reflecting the higher share price, there are few more consistent sources of passive income in the UK’s top tier.
However, I do think the valuation is looking a bit frothy. I’d be seriously impressed if the shares could sustain quite the same momentum going forward.
