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BAE Systems‘ (LSE:BA.) shares have been on a bumpy ride since last summer. But the defence contractor’s share price is still significantly higher than it was before Russia invaded Ukraine in early 2022.
In the last five years, the price has doubled, to £13.38. With dividends included, someone who invested £10,000 in the FTSE 100 firm back then would have made £21,972.
That’s a spectacular return, especially compared with the broader Footsie wich has risen ‘just’ 18% in that time. But past performance isn’t always a reliable guide to the future. So what can we expect from BAE Systems’ shares looking ahead?
Spending calls
As I say, the defence giant’s shares have been more volatile in recent months. This is perhaps no surprise, with many investors booking profits following those earlier gains, and fears that defence spending may begin cooling.
But BAE Systems shares have burst back into life in recent days. On Monday (17 February) they soared 9% on the day as European leaders met to discuss the war in Eastern Europe.
A planned summit between the US and Russia on the Ukraine war today hasn’t fuelled hopes of a peaceful resolution. It’s instead fuelled speculation that European arms spending will surge as the US takes a reduced role in safeguarding the continent’s security.
UK Prime Minister Keir Starmer on Monday (17 February) called for European nations to “step up” and “increase our defence spending and take on a greater role in NATO“. This follows similar comments from other key politicians, including European Union President Ursula von der Leyen who’s called for “hundreds of billions of more investment every year“.
Good and bad
As one of the world’s major defence suppliers, BAE Systems is well placed to capitalise on any spending boom. While it makes around a quarter of sales from the UK, it also ships a lot of hardware to Mainland Europe. In 2023, around 11% of sales came from its continental partners.
The business makes roughly another 5% from other NATO members Canada and Australia. These relationships leave it in one of the box seats to enjoy a spending boom across the defence bloc.
That said, there’s no guarantee that sales to the US will ignite under President Trump. In fact, BAE Systems could be a victim of defence cuts as Elon Musk’s Department of Government Efficiency gets into gear. This could be a huge problem, given that more than 40% of group sales come from the US.
The verdict
So should investors consider it today? I believe BAE Systems is hugely attractive. Regardless of US intentions, the defence industry could enjoy a massive cash injection that might lift earnings through the roof.
City analysts think BAE’s earnings will continue rising strongly over the next couple of years at least. Bottom-line growth of 13% and 10% is forecast for 2025 and 2026 respectively.
Medium-term forecasts are supported by its robust order backlog, which was a record £74.1bn as of last June.
Today, BAE Systems trades on a price-to-earnings (P/E) ratio of 17.8 times. This is well below the global defence average of around 29 times, and could leave scope for big gains as arms spending ramps up.
On balance, I think investors could enjoy spectacular returns over the next five years if they consider this stock.
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