BAE Systems’ (LSE: BA) shares have fallen 12% from their 5 June one-year traded high of £19.98. While this could signal the company is worth fundamentally less than it was before, it might also mean the stock could actually be a bargain.
I ran the key numbers and took a deep dive into the business to determine what the case is here.
Is it a bargain?
My starting point in assessing share prices is to compare their key valuations with those of their competitors. In BAE Systems’ case, its price-to-sales ratio of 1.9 is bottom of its competitor group, which averages 4.6. This group consists of L3Harris Technologies at 2.4, RTX at 2.5, Rolls-Royce at 4.5, and TransDigm at 9.1.
So it is very undervalued on this key comparative measure.
The same is true of its 26.6 price-to-earnings ratio against its peers’ average of 31.1. And it is also the case with BAE Systems’ 4.9 price-to-book ratio compared to the 14.1 average of its competitors.
The second part of my share price assessments involves running a discounted cash flow (DCF) analysis. This highlights where any firm’s share price should trade, derived from cash flow forecasts for the underlying business.
The DCF for BAE Systems shows its shares are 33% undervalued at their current price of £17.54. Therefore, their fair value is £26.18.
Consequently, they are a significant bargain right now.
How does the underlying business look?
BAE Systems’ results over recent years have looked very good to me. In 2024, for example, its year-on-year earnings jumped 14% to £3.015bn, with sales increasing the same degree to £28.335bn. Ultimately, earnings are the key driver for any firm’s share price over the long term.
A risk to these for BAE Systems is a failure in any of its core products. This could be very costly to remedy and could cause lasting damage to its reputation. However, at that point, the firm said it expects earnings growth of 8-10% this year. It also forecast 7-9% sales growth over the period.
Its H1 results saw underlying earnings leap 13% year on year to £1.55bn, and sales jump 11% to £14.621bn.
Given these strong figures, BAE Systems upgraded its previous key performance forecasts. It now expects earnings to increase 9-11% (from the previous 8-10%). And it projects sales growth of 8-10% this year (up from the earlier 7-9%).
Consensus analysts’ forecasts are that the firm’s earnings will grow by 11.3% each year to end-2027 at minimum.
So will I buy more of the stock?
I believe that BAE Systems’ strong earnings growth will power its share price towards its fair value over time. I think the only reasons it has dipped since June are profit-taking and over-optimism about the Russia-Ukraine war.
However, I do not believe for a second that a meaningful ceasefire is close. And even if an agreement is made, I do not think that global threats will abate, much as we hope they will.
I also believe all NATO members now believe that the most effective way to prevent war is to invest in defence. Consequently, I will buy more BAE Systems shares very soon indeed.
