BAE Systems (LSE: BA) shares have flown lately, as the West wakes up to the need to arm itself. But they’ve been blown away by rival defence-focused stocks Babcock International Group (LSE: BAB) and Rolls-Royce Holdings (LSE: RR).
After their strong run all three now look pricey, but I think this could be an exciting buying opportunity for one of them. So what makes me say that?
Flying FTSE 100 stocks
Over the last 12 months, the BAE Systems share price is up 35%, while Babcock rocketed 117%. Over five years their performance is pretty similar, at around 220%.
Rolls-Royce is a slightly different fish, as defence is only part of the story, given its civil aerospace and power systems operations, and a big potential growth opportunity in small modular reactors, or mini-nukes.
Rolls-Royce shares are up 85% over the last year and an extraordinary 735% over five. But all three present investors with the same question: can they keep climbing at this lightning pace?
Investors need to tread carefully around Rolls-Royce. It’s incredibly expensive, with a price-to-earnings ratio of almost 54, miles above the FTSE 100 average of 17. Profits and revenues will need to grow at a tremendous lick to justify that valuation.
Rolls is doing well, reiterating full-year 2025 guidance for underlying operating profit of between £3.1bn and £3.2bn last month, despite supply chain pressures. CEO Tufan Erginbilgic reckons its mini-nukes could turn Rolls-Royce into the biggest UK company of all. I’ll hold on to my shares while we wait to find out, but investors should think hard before considering them at today’s price.
I also suspect Babcock may be played out for now. As the smallest of the three, it flew under the radar for years, until its stellar run made it impossible to ignore.
Babcock is nowhere near as expensive as Rolls-Royce, with a P/E of 22.8, but investors may have to accept that the short-term excitement is over.
Are these stocks too expensive?
BAE Systems is the one that intrigues me. While shares in the other two hold steady, it’s fallen 15% in the last six months, most of that in the last month. And that’s despite confirming full-year guidance of 11% profits growth last month, supported by a bumper order book with another £27bn secured this year. Maybe demand has dipped on hopes of some kind of peace deal in Ukraine, although I can’t imagine investors are that naive.
BAE Systems isn’t exactly cheap, with a P/E of 24.6. But buying opportunities have been rare lately, so this may be as good as it gets for a while.
Consensus forecasts deliver a one-year median price target of 2,047p for BAE. If correct, that’s more than 22% above today’s 1,673p. That reinforces my optimism. I think the shares are well worth considering.
I’ve checked forecasts for Rolls-Royce, and analysts see around 16% upside over the next year to 1,259p. That surprised me, so maybe I should be more positive. And Babcock? Brokers have a 12-month target of 1,295p, up 13% from today. Again, that’s better than I anticipated.
There may still be a buying opportunity across all three, which isn’t surprising in today’s warlike world. But given the recent dip, I think it’s worth considering BAE Systems first.
