BAE Systems (LSE: BA) shares have had a good run recently. Since 5 November, when I wrote that the FTSE 100 stock looked very cheap, its share price has surged about 18%.
Looking at the investment case, I think the shares have the potential to keep rising. Here, I’ll explain why I think BAE Systems is a good stock to buy today.
UK defence spending boom
According to a report from the BBC this morning, the UK government is primed to announce it will spend an extra £4bn per year over the next four years on defence. This would be its largest military investment in 30 years and represent a 10% increase on the existing annual budget of around £40bn. The extra money will be used to modernise the armed forces, with more spent on robots, autonomous systems, and meeting new threats in the domains of space and cyber, according to experts.
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I see this development as a real positive for BAE Systems. BAE is a major contractor to the UK Ministry of Defence. Last year, 19% of total sales came from the UK. Given that BAE has been boosting its cybersecurity capabilities in recent years, I think it looks very well-placed to benefit from this extra defence spending.
Joe Biden’s defence plan
It’s worth noting that the UK isn’t the only country looking to modernise its armed forces today. In the US, military modernisation is also a key theme.
Indeed, earlier this year, Joe Biden made it clear that if he is elected as President, he’ll push for continued military modernisation. His goal is to shift investments from “legacy systems that won’t be relevant” to “smart investments in technologies and innovations — including in cyber, space, unmanned systems and artificial intelligence.
“We have to focus more on unmanned capacity, cyber and IT, in a very modern world that is changing rapidly,” Biden said in September.
Again, this should benefit BAE Systems. Last year, 43% of group sales came from the US.
I’m bullish on BAE Systems shares
I’ll point out that future government defence spending isn’t the only reason I’m bullish on BAE Systems shares right now. Recently, there have been a few developments that have been very encouraging.
One was BAE’s trading statement on 11 November. Here, the group said demand for its capabilities remains high. It also upgraded its earnings forecast for the year.
Another was a recent research note from JP Morgan, which currently has an ‘overweight’ rating on the FTSE 100 stock. In the note, its analysts wrote that BAE Systems shares are “significantly undervalued.”
A third was a large purchase of stock from BAE’s chairman back in late July (40,546 shares at 493p per share). This suggests the insider – who’s likely to have an information advantage over the rest of us – is confident about the future and expects the stock to rise. Today, the share price is only 3% higher than the price he bought at.
BAE Systems: low valuation and attractive yield
Analysts expect BAE to generate earnings per share of 48.9p next year. That puts the stock on a forward-looking P/E ratio of 10.4. I think that’s a steal. A prospective dividend yield of about 5% adds weight to the investment case.
All things considered, I think BAE Systems is a good stock to buy today.
