BAE Systems (LSE: BA) suffered in the stock market crash, along with fellow aerospace engineer Rolls-Royce. But the similarity largely ends there, and shows the defensive nature of the, erm, defence industry compared to companies reliant on discretionary consumer spending. While Rolls shares are down more than 50% over the past five years, the BAE Systems share price has lost only 3%.
That’s still a bit behind the FTSE 100, up 4% over the same timescale. But over the past 12 months, BAE has put on 27%, almost exactly double the Footsie’s gain. It appears positive investor sentiment is returning to BAE. And I think we could be in for a few years of outperformance. Here’s why.
Firstly, I think the pandemic downturn has had a possibly long-term effect on a lot of investors. As a result, I believe we could be in for a few years of focus on safety. That helped companies like Tesco and Unilever, to hold up when when all around were crashing. But more than that, I’m increasingly hearing talk that suggests investors are becoming more aware of the best time to buy safety stocks. It’s not after a crash has happened, and it’s not when we’re in the middle of a slump.
No, the best time to buy defensive shares is surely before the next crash, before the next economic slide, before the next oil price shock. But how do we know when those things are going to happen? We don’t. But that just means the best time to invest defensively is… all the time. And hold on for the long term.
A good decade ahead?
Do I think BAE has defensive qualities, and do I expect the BAE share price to do well over the next decade? I do, and it’s more than just changes in sentiment. There are two fundamental things about BAE that make me like it — earnings and dividends. BAE has been generating strong earnings for years, and has been paying a generally progressive dividend.
The nature of the business, with multi-year, long-term contracts, means earnings can be erratic on a year-by-year basis. And BAE Systems deferred its 2019 dividend, as did many others after Covid-19 struck. But the 7.7% yield paid in 2020 included a compensating amount, which made up for the brief pause.
BAE share price too low?
BAE is also doing something that I like, and that’s buying back its own shares. That, in my view, is almost always a good thing. I saw almost, because companies sometimes have more focus on their own share prices for my liking, rather than concentrating 100% on the business itself. But I’ve always seen BAE as conservatively managed. And if the board thinks repurchasing shares is the best thing to do with surplus capital, then I’m confident that they genuinely see the stock as undervalued.
What’s the downside with the BAE share price? The company’s exposure to the US market adds risk, as any weakening in defence spending there could hit overseas suppliers disproportionately. I also sometimes feel a bit twitchy over the company’s close ties to Saudi Arabia. Price-to-earnings multiples in the sector are often lower than the FTSE average too, so I expect valuations to remain unexciting. But BAE is definitely on my buy list.
