Over the past year, Rolls-Royce shares have more than doubled, moving up by 101%.
But another UK defence share has done even better during that time, growing in value by 113%. That company is Babcock (LSE: BAB).
Over five years, Babcock has moved up by an impressive 488%. Still, that is weaker than the incredible 1,200% gain in the value of Rolls-Royce shares over that period.
Over the past year, both shares have performed brilliantly — but Babcock has done better than Rolls.
Investing a spare £1,000 today would let me buy 74 Babcock shares. Should I invest?
Here’s why Babcock has been doing well
Actually I did buy the shares a few years ago when they were far below today’s price and struck me as a bargain. But they went nowhere fast and I sold them after holding them a while.
As a sidenote, the same was true for Rolls-Royce shares: I sold at a profit but missed much of the past few years’ massive price gain.
Both moves underline why I ought to have taken an even-longer-term approach to those investing.
So why did Babcock shares suddenly take off in recent years, after having lost over 80% of their value between 2014 and 2021?
Partly it reflected a more strategically focused business. But, like Rolls-Royce, Babcock has benefitted from surging demand for defence equipment as well as power equipment – and that has helped the share price.
Potential for further business growth
The company’s most recent interim results illustrate that. Revenues were up 5% year on year, but basic earnings per share grew 31% and the interim dividend was raised by 25%.
With exposure to both the energy and defence sectors, Babcock is well positioned to ride robust demand in coming years.
Something I like about the business is that much of its work stretches over decades. That can risk cost overruns, but more positively it helps visibility of future revenues.
There are a limited number of competitors who can provide the services Babcock does, meaning it has pricing power and can build long-term customer relationships.
Should I buy again?
Still, while a share price gain of almost 500% in five years is great for existing shareholders, it does make me wonder how attractive a purchase the stock is for my portfolio right now.
The price-to-earnings ratio is 24. That is cheaper than some rivals: BAE Systems shares sell for 31 times earnings, for example, while Rolls-Royce shares are even costlier, at 43 times earnings.
However, while Babcock may look cheap by comparison, in absolute terms I still think that valuation is quite high. Of course, it may be cheaper long term, as earnings could grow in coming years. But that remains to be seen.
I would like a bigger margin of safety when investing, though. Like any business, Babcock faces risks, such as the recent subdued level of activity at its rail business continuing.
So, at the current price, I will not be buying any of the shares.
