BAE (LSE: BA) (NASDAQOTH: BAESY.US) may not strike you as a company with above-average growth prospects. After all, it seems as though the defence sector is going through a challenging period at the moment, with governments across the world cutting spending.
Defence, it seems, is an area where cuts can (and will) be made.
However, BAE is forecast to increase earnings per share (EPS) by 9% this year. This is above the 4-5% average of the FTSE 100 and is a positive surprise, since BAE is often pigeon-holed as little more than an income stock for investors who are more concerned with yields than the potential for capital growth.
In addition to earnings having an impressive forecast growth rate, BAE currently trades on a relatively undemanding price-to-earnings (P/E) ratio. Although the industry group to which it belongs (industrials) has a P/E of 23.7, BAE trades on a P/E of just 10.
However, the impressive value offered by the shares is best highlighted when combining the strong growth rate of earnings and the relatively low P/E ratio so as to generate the PEG ratio. This puts BAE on a PEG of 1.11 — just above the PEG sweet spot of 1.0.
Indeed, the current P/E of BAE certainly seems to have the potential to increase. So, if the PEG ratio were to increase to just 1.25 (which is still relatively low for a solid FTSE 100 company) it would mean shares trading at a price of around 480p. This would represent a gain of around 13% versus the current share price.
Of course, shares are unlikely to post such gains in the short run. However, over the medium to long term such gains do seem to be achievable and, when the current yield of 4.8% is added to the potential capital gains over the medium term, a total return of 20%+ is plausible.
Certainly, shares could fluctuate in the meantime, with defence budgets remaining under pressure. However, BAE offers investors a well-covered and generous dividend yield, above average growth potential and comes with a P/E ratio that is less than half its sector.
