The BAE Systems (LSE: BA) share price has enjoyed an astonishing run. As the company is Britain’s leading defence manufacturer, that’s hardly surprising. Geopolitical tensions continue to escalate, with the world entering a new arms race.
The Iran conflict has taken things up another notch, pushing defence stocks higher still. They’ve provided valuable diversification for investors, me included, at a time when many other holdings have been hit by events in Iran.
BAE Systems shares are up 40% over the last year and 335% over five years, with dividends on top. It’s a remarkable performance. Long-term investors will be delighted, even if the circumstances driving those gains are less welcome.
Given recent events in the Middle East, investors might expect BAE Systems shares to have surged over the past month. But they’ve been broadly flat.
The FTSE 100 is flying today
Why? Valuation could be one reason. With a price-to-earnings ratio nudging 30, some investors may feel there’s limited upside left in the short term. I’ve held the shares for several years, and while performance has been strong overall, there have been periods of consolidation as investors wait for the next leg higher. Shares rarely move in a straight line.
It’s also worth comparing BAE with its smaller FTSE 100 peer, Babcock International Group. Long-term performance there has been even stronger, with the shares up 60% over the past year and more than 400% over five years. Yet, interestingly, Babcock shares have fallen 16% over the past month. Similar forces may be at play. Like BAE shares, they no longer look especially cheap.
There’s also a broader question. While Western European countries are under pressure to increase defence spending, can they really afford to, given the strain on public finances? We’re seeing that domestically. The UK government faces calls to lift defence spending to 3% of GDP, but progress has been slow, frustrating suppliers. Politicians are not exactly flush with cash these days.
This morning, the FTSE 100 is up 1.75% on hopes of easing tensions in the Middle East. Among the biggest risers is Rolls-Royce Holdings, which also has defence exposure. Its shares are up 6.8%. Babcock is close behind, rising 5.5%.
Defence stocks still in demand
That’s slightly surprising. I would have expected defence stocks to fall on peace hopes. Perhaps this suggests investors believe uncertainty will persist, particularly if Iran retains control of the Strait of Hormuz. Add in concerns about the future of NATO, with Donald Trump raising doubts about his commitment, and the case for sustained European defence spending remains strong.
Despite this, BAE Systems shares have edged up just 1%. They’re not fully participating in the latest rally. Again, valuation may be the sticking point. BAE offers reliable revenues and a substantial order book, providing strong earnings visibility. But after such a powerful run, the shares may simply need time to consolidate.
That doesn’t diminish the long-term story. I still see BAE Systems as a high-quality, core holding. However, in the short term, investors might consider holding back. There are plenty of exciting growth opportunities elsewhere in the FTSE 100. Despite this morning’s bounce, I think many still look attractively priced.
