FTSE 100 defence heavyweight BAE Systems (LSE: BA) has seen its shares power higher in recent years. This followed rising long-term global defence spending that has benefited it as Europe’s largest defence contractor, and the world’s sixth‑largest.
The firm has continued to post strong results, characterised by surging orders, earnings and cash flow. It is embedded in some of the world’s most strategically important defence programmes.
Yet despite all this, the shares still look materially undervalued when compared with the company’s international peer group. And this disconnect has only widened after a recent 14% dip in price.
So, is now the time for me to add to my holding?
How do the valuations stack up?
Despite its price gains over the last few years, BAE’s price-to-sales (P/S) ratio of just 2.2 is bottom of its peer group.
This comprises RTX at 2.7, L3Harris Technologies at 2.8, Rolls-Royce at 4.4, and TransDigm at 7.4. The average P/S of these firms is 4.3, so BAE is very cheap on this basis.
It also looks a bargain on its 5.4 price-to-book ratio compared to its competitors’ average of 13.8. And it still looks cheap at a price-to-earnings ratio of 30.4 against a peer average of 31.6.
For a company of BAE’s scale, quality and strategic importance, that valuation gap looks difficult to justify. And for long‑term investors, that disconnect could represent a rare opportunity in a sector where genuine bargains are hard to find.
Is the core business strong?
Gains in any company’s share price are driven over the long run by sustained earnings (‘profits’) growth.
A risk to BAE is any major failure in one of its products that could prove costly to remedy and could damage its reputation. Another would be supply‑chain issues that might disrupt production schedules and push up costs.
Nevertheless, in the firm’s 2025 results, management said it expects 2026 underlying operating profit growth of 9%–11%.
And analysts forecast 12.1% average annual earnings growth to the end of 2028, at minimum.
What are the earnings growth drivers?
Those 2025 results showed underlying earnings before interest and taxes jumping 12% year on year to £3.3bn, highlighting improved operational efficiency and disciplined contract execution.
Both should continue to support strong margin expansion.
Meanwhile, sales rose 10% to £30.7bn, underlining strong momentum behind its long‑dated contract programmes. These include such programmes as the Eurofighter Typhoon, the Dreadnought‑class submarine, and space‑based missile‑tracking satellites for the US Space Force.
Underpinning all this was order intake of £36.8bn pushing the backlog to a record £83.6bn.
My investment view
NATO ex-US members have now pledged to lift combined defence budgets to 5% of GDP by 2035, up from around 2% last year. It is an increase worth around $423bn (£314bn) a year.
Meanwhile, the US defence budget reached approximately $919bn last year. There are proposals to raise this to around $1.5trn a year by 2027.
BAE is already integrated into the heart of key defence programmes relating to land, sea, air and space. And these mark a long-term structural shift toward boosting deterrence to deter aggression, rather than a temporary fix to short-term conflicts.
Consequently, I will be buying more of the stock very soon. And I have my eye on shares in other sectors that are also undervalued with strong earnings profiles.
