The Motley Fool

A cash-rich FTSE 250 stock I’d buy alongside the BAE share price

Image source: Getty Images.

I’ve always considered the defence business a safe and attractive long-term investment target, and I think valuations are looking attractive right now.

Good start

QinetiQ Group (LSE: QQ) shares are up 3% as I write after the defence technology firm released a Q1 update. With “a good start to the new financial year with strong operational performance,” the firm’s revenue under contract is up to 85%, from 74% in April.

5G is here – and shares of this ‘sleeping giant’ could be a great way for you to potentially profit!

According to one leading industry firm, the 5G boom could create a global industry worth US$12.3 TRILLION out of thin air…

And if you click here we’ll show you something that could be key to unlocking 5G’s full potential...

QinetiQ has expanded and strengthened a number of its contracts with the MoD, and reckons it’s on track to meet its prior expectations for the year to March 2020, as expounded with FY 2019 results released in May. Back then, the company said it expected to record mid-single-digit revenue growth in 2020, after having “delivered a third successive year of organic revenue growth and an organic increase to operating profit,” and the latest update reiterates that.

I can’t help suspecting that current forecasts are a little too bearish, as they suggest a 3% drop in EPS this year, followed by a modest 2% move upwards in 2020. And the stock’s P/E valuation of around the 14 mark looks attractive, especially when we consider that QinetiQ was sitting on net cash at its last year-end, and does not shoulder net debt as many companies on similar valuations do.

Dividends are part of the picture, and though they’d deliver a yield of only 2.5% on the latest forecasts, cover by earnings would come in around 2.7 times. And dividends have been steadily progressive — the 7p per share on the cards for the current year would take the annual payment up 30% over five years, and that’s rising at more than twice the UK inflation rate over that period.

If you do invest in QinetiQ, I think you’ll have to be prepared for some volatility. As well as the industry being cyclical, the multi-year nature of many defence contracts can make year-by-year earnings look like too short a timescale to provide an accurate picture.

Short-term weakness

BAE Systems (LSE: BA) shares might look like they’re on a cheaper valuation compared to QinetiQ’s, with a more modest forward P/E of 11.6 this year, dropping to 11 for 2020. But one difference is that BAE carries net debt, which stood at £904m at its last year-end.

Taking that into consideration, I think it’s harder to separate the valuations of the two companies, though BAE’s has fallen in recent years. Despite steady and slowly rising earnings, share price weakness has dropped the stock’s P/E from 14.7 in 2016 — and I thought that was an attractive valuation at the time. Over the same period, dividends have been growing steadily and are forecast to yield 4.4% this year (and 4.6% next), though cover is a bit less than QinetiQ’s at around two times.

Part of the weakness of the past couple of years has surely been down to uncertainty over BAE’s long-term association with Saudi Arabia, which has traditionally been one of the UK’s biggest defence customers.

But I see that as just part of the cyclical nature of the business, based on long-term global politics. The defence industry is an unfortunately necessary one, and one that I think will continue to be profitable for investors for many years.

“This Stock Could Be Like Buying Amazon in 1997”

I'm sure you'll agree that's quite the statement from Motley Fool Co-Founder Tom Gardner.

But since our US analyst team first recommended shares in this unique tech stock back in 2016, the value has soared.

What's more, we firmly believe there's still plenty of upside in its future. In fact, even throughout the current coronavirus crisis, its performance has been beating Wall St expectations.

And right now, we're giving you a chance to discover exactly what has got our analysts all fired up about this niche industry phenomenon, in our FREE special report, A Top US Share From The Motley Fool.

Click here to claim your copy now — and we’ll tell you the name of this Top US Share… free of charge!

Alan Oscroft 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.

Where to invest £1,000 right now

Renowned stock-picker Mark Rogers and his select team of expert analysts at The Motley Fool UK have just revealed 6 "Best Buy" shares that they believe UK investors should consider buying NOW.

So if you’re looking for more top stock ideas to try and best position your portfolio in this market, then I have some good news for your today -- because we're offering a full 33% off your first year of membership to our flagship share-tipping service, backed by our 'no quibbles' 30-day subscription fee refund guarantee.

Simply enter your email address below to discover how you can take advantage of this.

I would like to receive emails from you about product information and offers from The Fool and its business partners. Each of these emails will provide a link to unsubscribe from future emails. More information about how The Fool collects, stores, and handles personal data is available in its Privacy Statement.