Why Neil Woodford has just dumped BAE Systems plc… and what he’s bought instead!

Why has top investor Neil Woodford ditched BAE Systems plc (LON:BA), and what stocks has he been buying?

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Master investor Neil Woodford has made notable disposals of several FTSE 100 companies this year. BAE Systems (LSE: BA) is the latest casualty. If you’re invested in this defence giant, should you be worried and consider selling?

To understand why Woodford has ditched BAE we should bear in mind the investment approach and target return of his flagship equity income fund. He invests in companies on a three-to-five-year view, monitoring their prospects over this timescale on a rolling basis. The target of the fund is to deliver high single-digit annualised returns over the long term.

Looked at in this context, we can understand the explanation of the sale of BAE provided by Woodford’s head of investment communications, Mitchell Fraser-Jones.

Should you invest £1,000 in Ssp Group right now?

When investing expert Mark Rogers has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for nearly a decade has provided thousands of paying members with top stock recommendations from the UK and US markets. And right now, Mark thinks there are 6 standout stocks that investors should consider buying. Want to see if Ssp Group made the list?

See the 6 stocks

Prospective returns

Fraser-Jones writes: “In very simple terms, our total return expectation for a stock equals its dividend yield plus the anticipated rate of dividend growth.” In the case of BAE, the forecast current-year yield is 4.1%, while forecast growth on a three-to-five-year view is 2.3% a year, suggesting a return of 6.4% per annum — below Woodford’s high single-digit target for his fund.

The calculation is based on the share price growing at the same 2.3% a year as the dividend, and as Fraser-Jones says: “We could argue for hours about whether or not that is a realistic growth expectation.” Woodford and his team reckon BAE might do slightly better than the analyst consensus but, even so, they see significantly more attractive prospective returns elsewhere.

Sub-prime lender Provident Financial — a holding Woodford has been adding to in recent months — is one example. The starting yield is 4.6% and forecast growth is 15.9% per annum over the next three years, suggesting a prospective return of 20.5% a year.

The dividend yield/growth calculation is a simple but useful instrument to add to your valuation toolbox. You may want to try it out on other shares Woodford has been buying recently — including Legal & General, Capita and Babcock International — and, indeed, on stocks in your own portfolio.

Pension risk

As well as BAE’s relatively low-key growth prospects, Woodford is also somewhat concerned about the company’s substantial pension deficit. This has become a bit of a theme for him in the current environment of ultra-low interest rates, having also been one of the risk factors he referred to in his previous big blue chip disposal, BT Group (LSE: BT-A).

As the table below shows, the pension deficits of both companies add significantly to their liabilities, with net debt plus pension shortfall being markedly in excess of shareholders’ funds (equity).

  Equity (£bn) Net debt (£bn) Pension deficit (£bn)
BT 10.2 9.6 7.6
BAE 2.6 2.0 6.3

Lower interest rates make pension funding more onerous, and, although Woodford doesn’t say it explicitly, the implication is that more of the companies’ profits may have to flow to pensioners, potentially crimping increases of shareholders’ dividends.

Personally, I see the 6.4% annual return (or slightly better) Woodford posits for BAE as fairly attractive in a low-growth world, while, according to my calculations, the BT prospective return is 14.9%.

Pension deficits could represent a risk to dividend growth on a three-to-five year view, but at some point interest rates will surely rise and deficits fall. As such, I reckon BAE and BT remain fairly attractive propositions for investors buying and holding for the long term.

But there are other promising opportunities in the stock market right now. In fact, here are:

5 stocks for trying to build wealth after 50

The cost of living crisis shows no signs of slowing… the conflict in the Middle East and Ukraine shows no sign of resolution, while the global economy could be teetering on the brink of recession.

Whether you’re a newbie investor or a seasoned pro, deciding which stocks to add to your shopping list can be a daunting prospect during such unprecedented times. Yet despite the stock market’s recent gains, we think many shares still trade at a discount to their true value.

Fortunately, The Motley Fool UK analyst team have short-listed five companies that they believe STILL boast significant long-term growth prospects despite the global upheaval…

We’re sharing the names in a special FREE investing report that you can download today. We believe these stocks could be a great fit for any well-diversified portfolio with the goal of building wealth in your 50’s.

Claim your free copy now

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

G A Chester has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Electric cars charging in station
Investing Articles

Looking at Tesla stock? Consider this Warren Buffett-held EV rival instead

Tesla stock is one of the most popular investments in the UK right now. However, Edward Sheldon sees more appeal…

Read more »

Investing Articles

Up 18% in the past week, I think this FTSE 100 share could keep soaring!

While the FTSE 100's up 5.6% in the past week, this blue-chip share's risen much more sharply. Can it move…

Read more »

Concept of two young professional men looking at a screen in a technological data centre
Investing Articles

2 top growth stocks to consider buying for the next phase of the AI revolution

The artificial intelligence (AI) revolution is advancing rapidly on the application side, setting up these two growth stocks for more…

Read more »

Growth Shares

Will the Lloyds share price be a winner or loser from the tariffs turmoil?

Jon Smith explains both sides of the argument when trying to figure out if the Lloyds share price will move…

Read more »

Investing For Beginners

Aston Martin: is there a real risk the FTSE company goes bust?

Jon Smith notes the struggles over the past few years of an iconic car brand, but explains why his head…

Read more »

Growth Shares

2 crackerjack growth shares to consider buying as the dust settles

Jon Smith talks through a couple of growth shares that he feels represent good value for investors right now as…

Read more »

Mindful young woman breathing out with closed eyes, calming down in stressful situation, working on computer in modern kitchen.
Investing Articles

I’ve been investing in the stock market for 25 years. Here are 4 tips to navigate the current volatility

Investing during periods of extreme stock market volatility isn’t easy. Here, Edward Sheldon provides his top tips to get through…

Read more »

Investing Articles

£10,000 invested in Tesla shares a fortnight ago is now worth…

Despite extreme volatility, the value of a £10,000 investment in Tesla shares from a fortnight ago hasn’t changed much. That’s…

Read more »