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The BAE share price has slumped over 20%. Is it time to buy?

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Shares of FTSE 100 defence giant BAE Systems (LSE: BA) are down over 20% from their summer high. The same goes for the £900m-cap AIM-listed technology firm First Derivatives (LSE: FDP) — despite its shares jumping as much as 10% in early trading this morning after it released its half-year results. Do I think now is a great time to invest in these two businesses?

Ahead of forecasts

First Derivatives provides software to financial institutions and, increasingly, to other industries. It reported a 20% increase in first-half revenue to £105.6m, and a 12% rise in adjusted earnings before interest, tax, depreciation and amortisation (EBITDA), to £18.1m. Management expressed its confidence in the group’s growth prospects, saying: “We expect to deliver revenue and adjusted EBITDA slightly ahead of consensus forecasts for the year to 28 February 2019.” These forecasts were £213m and £38.5m, respectively.

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I reckon the guidance translates into adjusted earnings per share (EPS) in the region of 85p (H1 was 41p). This would put the stock on a price-to-earnings (P/E) ratio of 41, at a share price of 3,500p. The price is around the same level as this time last year when my colleague Edward Sheldon was reluctant to add to his personal shareholding.

While the forecast EPS is now higher than when Ed was writing, I’m not convinced that the P/E and a prospective dividend yield of 0.8% represent good value. As such, it’s a stock I’m content to avoid, simply on valuation grounds, without having to consider criticisms levelled in recent months by short-seller ShawdowFall. Among them were the company’s accounting (including “shielded costs from its P&L”), the nature of its Kx Tech Fund (“at worst, we believe this could be viewed as straightforward vendor financing”), and corporate governance (“KPMG Belfast has been auditor to FD for over nineteen consecutive years”).

Blue-chip bargain

I’m much more confident that there’s great value on offer over at £17bn-cap blue-chip BAE Systems. The consensus among City analysts forecast an EPS posting of 43p this year, increasing by 9% to 47p in 2019. At a current share price of around 520p, the P/E is just over 12, falling to little more than 10 next year. Dividend forecasts of 22.7p, followed by 23.6p, give a yield of 4.4%, rising to 4.5%, continuing a record of steadily increasing payouts for shareholders.

I reckon October’s stock market slump and concern about the UK’s relationship with Saudi Arabia (an important customer for BAE) in the wake of the murder of journalist Jamal Khashoggi, have created the current investment opportunity. I don’t expect either of these factors to impact on BAE’s long-term future, which I see as underpinned by defence spending which is only likely to increase in the coming decades.

The near-term outlook is also good, according to the company. It said in its half-year results: “With a large order book and a positive outlook for defence budgets in a number of key markets, we have a strong foundation to deliver growth and sustainable cash flow.” As such, I rate the stock a great ‘buy’ today.

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G A Chester has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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