The more talk of a Ukraine peace deal, the lower BAE Systems’ (LSE: BA) share price seems to drift. But the market is missing the key point in my view.
Given this, and the strong earnings growth expected, I think the stock looks a huge bargain. So what is the market missing, and how high could the share price go?
What’s the key point here?
The crucial point is NATO has committed to more than doubling defence spending — regardless of any Ukraine peace deal. This is a structural shift designed to create a long‑term deterrent against future aggressors, not a temporary wartime spike.
Last June, non‑US members agreed to lift defence budgets to 5% of gross domestic product by 2035, up from 2% last year. This equates to $423bn in additional annual spending across non‑US NATO members alone.
As Europe’s largest defence contractor — and the world’s sixth‑largest — BAE Systems sits at the centre of this investment cycle. Moreover, defence procurement is based on multi‑year, legally-binding contracts. So the market is pricing in a cyclical downturn when BAE’s revenue and profits are long-term and contractual.
That disconnect is where the opportunity lies. It is what makes the firm a classic short‑term volatility/long‑term reward play, in my view.
Results show momentum building
This structural spending shift is evident in BAE Systems’ results. Its 30 July half‑year 2025 figures saw group-reported sales up 11% year on year to £14.6bn. Earnings before interest and tax (EBIT) rose 13% to £1.55bn, while basic earnings per share increased 11% to 34.7p. Order intake hit £13.2bn, powering a huge £75.4bn order book and giving multi‑year revenue clarity.
Consequently, management upgraded full-year sales guidance to 8%-10% from 7%-9%. It also upgraded its underlying EBIT guidance to 9%-11% from 8%-10%.
These numbers followed strong 2024 full‑year results. Sales rose 10% to £25.3bn, while underlying EBIT climbed 12% to £2.9bn. The order book hit a record £70.5bn. Taken together, these numbers show a business benefiting from higher defence budgets and a backlog that underwrites future growth.
A risk to this is any failure in one of the company’s key products, which could prove costly to remedy. However, consensus analysts’ forecasts are that BAE Systems’ earnings will grow 11.2% a year to end-2028.
Market pricing overlooks all this
Despite this momentum, the market is still pricing BAE Systems as if earnings are about to decline. The shares trade on a forward price-to-earnings ratio of 23.5 P/E against 28.5 in June. This is not what is expect for a business with multi‑year contracted revenue and double‑digit earnings growth.
The discounted cash flow valuation shows BAE Systems shares are 28% undervalued at their current £17.50 price. So their ‘fair value’ is £24.31. And that matters, because asset prices tend to migrate towards their fair value over time.
My investment view
BAE Systems is forecast to achieve double‑digit earnings growth through 2026. This is supported by a record order book, upgraded guidance, and a decade‑long rearmament cycle already locked into NATO budgets.
In other words, the stock’s valuation implies a slowdown just as the fundamentals point to sustained acceleration. That gap between perception and reality is where the opportunity lies. Consequently, I will be adding to my holding in the firm shortly.
