Is the BAE share price a FTSE 100 bargain or a value trap?

Could BAE Systems plc (LON: BA) be the best buy in the FTSE 100 (INDEXFTSE: UKX)?

| 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.

Over the past five years, shares in defence contractor BAE Systems (LSE: BA) have more than doubled the return of the broader FTSE 100, excluding dividends.

However, compared with international peers such as General Dynamics and Boeing, BAE has struggled. Indeed since 2013, shares in BAE have underperformed those of General Dynamics by 100%, excluding dividends, and Boeing by 200%.

But with defence spending on the up around the world, could BAE’s fortunes finally be about to change?

Catching up with the pack

BAE’s underperformance, compared to its international peers, is staggering. Many factors have contributed to the company’s struggles, but the primary reason is inefficiency. BAE just isn’t as efficient as its larger US peers. 

For example, last year General Dynamics, which operates in reasonably similar areas to its British peer, achieve the return on capital employed — a key measure of profitability for every £1 invested — of 19%. Meanwhile, BAE’s ROCE was just 9% for 2017.

Still, despite the lack of profitability, BAE continues to pick up orders for its products from around the world. In a trading statement issued before the company’s AGM last week, the group said it had opportunities to win orders during the second half of 2018 in the US, to help build amphibious combat vehicles, and in Australia to help build warships. There’s also progress being made in negotiations with Saudi Arabia over its intention to buy 48 Typhoon fighter jets.

Based on these prospects, management believes that earnings will be “in line” with 2017 this year. This suggests a figure of 42.1p has put forward in the pre-AGM release, slightly below City forecasts.

What does the future hold? 

BAE’s lack of growth is concerning. At a time when governments around the world are ramping up military spending, BAE should be capitalising on its position in the market to drive earnings and revenue growth. 

Over the next two years, sales at General Dynamics are expected to grow by nearly $9bn, up 30% from 2017’s $31bn. Earnings per share are also set to rise by 30% over the same period. If BAE hits revenue growth targets, over the same period the company is projected to grow sales by 5%.

Considering the above, it’s difficult to think of BAE as a bargain. Shares in the company currently trade at a forward P/E of 13.9, which looks about right for a low-growth business. At the same time, the shares only support a dividend yield of 3.7% and this is unlikely to grow much further in the years ahead as earnings remain flat.

That being said, BAE doesn’t look to be much of a value trap either. Earnings are unlikely to fall dramatically if it continues to win contracts. And the dividend yield is well covered by earnings per share, so it’s unlikely investors will have to suffer a payout cut.

With this being the case, I am struggling to arrive at a conclusion either way for the stock. If it’s income and growth you are after, there’s certainly better buys out there, although my Foolish peer Harvey Jones seems to disagree

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.

Rupert Hargreaves owns no share 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.

More on Investing Articles

Smart young brown businesswoman working from home on a laptop
Investing Articles

A top S&P 500 growth share and an ETF I’d buy this November!

I think this S&P 500 share and exchange-traded fund (ETF) could be brilliant additions to my ISA or SIPP right…

Read more »

US Stock

Here are the best-performing S&P 500 stocks after the US election result

Jon Smith notes some of the largest gainers from the S&P 500 yesterday and explains how the election result has…

Read more »

Growth Shares

2 UK stocks knocking on the door of promotion to the FTSE 100

Jon Smith points out a couple of UK stocks that he feels could be ready for the big league based…

Read more »

Investing Articles

Rolls-Royce shares just fell 7%. Is it time to buy?

This investor in Rolls-Royce shares takes a look at the FTSE 100 engine maker's trading update to see what caused…

Read more »

Young Black woman looking concerned while in front of her laptop
Investing Articles

What’s going on with the Auto Trader share price?

Paul Summers takes a closer look at why the Auto Trader share price has tumbled despite the company posting higher…

Read more »

Investing Articles

Legal & General shares look set to give me a mind-blowing 10.22% yield in 2026!

Harvey Jones is getting a brilliant second income from his Legal & General shares and expects even more to come.…

Read more »

Investing Articles

I’d consider this beaten-down FTSE 100 dividend stock to target a second income of £19,000

Our writer sees an opportunity to earn a substantial second income by investing in this UK insurance giant. Here’s his…

Read more »

Investing Articles

How cheap is the 72p Vodafone share price?

The Vodafone share price looks very cheap having fallen to a 72p price tag. But is it really the bargain…

Read more »