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I think the BAE share price is one of the FTSE 100’s best bargains

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BAE Systems
Image source: BAE Systems

BAE Systems (LSE: BA) puzzles me. Over the past five years, we’ve seen EPS up by a total of 16%. That’s not brilliant, but not too shabby either. The 2019 dividend was deferred due to Covid-19. But BAE paid it as part of 2020’s dividends. And that means a modestly progressive dividend over the five years, yielding around 4.5%. But the BAE share price? It has gained just 7.6% over the five years, around half the level of the FTSE 100. And it’s been far more volatile than the index.

BAE shares are still lagging the Footsie in 2021, so what’s the company’s outlook like? Judging by the latest trading update on Wednesday, it’s just fine. Chief Executive Charles Woodburn said: “Our good operational performance underlines our confidence in the full-year guidance for top-line growth and margin expansion and our three-year cash targets.

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The update went on to say: “Group sales and underlying EBIT growth expectations in the full-year 2021 guidance remain on track. The guidance across all other metrics is unchanged.

BAE share price response

The market reacted coolly, with barely any movement in the BAE share price. So why are investors so unenthusiastic? As my Motley Fool colleague Royston Wild has pointed out, demand for BAE from institutional firms remains weak. All the environmental, social and governance (ESG) focus is turning these investors towards more fashionable green investments and away from defence. I do think investing in environmentally sound companies is a positive move. But I also reckon defence is one critical industry that will always be in demand, and will keep generating profits.

I believe Wednesday’s update reinforces my view. It said: “Our backlog and programme positions support our growth expectations in the coming years, and the pipeline of opportunities across all sectors remains strong. Demand for our capabilities remains high with order intake ahead of expectations.”

But, no matter how strong a company’s future might look, isn’t it still a poor investment if the big institutions are wary of it? Doesn’t that mean the shares are destined to remain undervalued? Well, that doesn’t matter in the slightest to me, as an income investor. Sure, if I wanted growth, and wanted it in the next five years, I suspect I wouldn’t get it from the BAE share price.

I’d buy for income

But I’m looking at a stock here that I reckon can give me a healthy 4.5% annual dividend yield. And if I’m getting 4.5% per year on my money, and I’m not looking to sell for years, why would I worry where the BAE share price goes? In reality, I’d prefer BAE to remain out of favour and undervalued so I can buy — and buy more — in the coming decade or so.

Of course, my plan could fall apart if something comes along and hurts the BAE dividend. That could put an end to my 4.5%, and cause the shares to drop further. But with BAE on a trailing P/E of only 11, I think there’s a safety margin that makes up for the risk. I’m very likely to buy BAE in the near future.

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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.

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