Sadly, I didn’t buy BAE Systems (LSE: BA) shares five years ago. Since then, they’ve grown at five times the rate of the FTSE 100 as a whole.
BAE is an aerospace and defence contractor, and its weapons are in demand these days, sadly. The stock is up 23.03% measured over one year, and 55.69% over five years. That compares to growth of 9.57% on the FTSE 100.
I like this defensive investment
Over five years, BAE shares would have turned a £1,000 investment into £1,557 from share price growth alone. My back-of-fag-packet calculation suggests dividends would have added another £200 or so on top of that.
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For most of that time, the stock traded at around 10 or 11 times earnings, but that was before the war in Ukraine. BAE Systems is more expensive today, trading at 16.4 times earnings. That’s hardly exorbitant though, given its performance and prospects.
Last month’s results showed a record £37.1bn order intake in full-year 2022, lifting BAE’s backlog to a hefty £58.9bn. Sales increased by 4.4% to £23.3bn, while underlying earnings per share increased 9.5% to 55.5p.
It’s rare to see such a healthy set of results in these uncertain times. Even the weak pound has pitched in, boosting the value of BAE’s overseas revenues once converted back into sterling. If the rest of the UK plc was doing as well, we’d be in much better place.
BAE Systems would have made me money over the last five years (and the last six months, as it is up another 17.03% in that time). But what about the future?
There aren’t many better FTSE 100 stocks
Its vast order backlog gives me immense comfort. Defence contracts tend to be long-term relationships, so this guarantees revenues well into the future. One potential (and longed for) ‘risk’ is that we get some resolution to the Ukraine conflict and peace breaks out elsewhere. Frankly, I don’t see that happening. The US/China stand-off looks more likely to intensify than ease.
Another worry is that cash-strapped Western governments will be forced to cut defence spending, hitting sales. Although in practice, defence is moving up the priority list.
BAE’s dividend isn’t the biggest on the FTSE 100. At 3%, it is well below the average yield of around 4%. That is largely a consequence of strong share price growth though. Happily, the payout is covered 2.1 times by earnings. Management has just increased the dividend by 7.6%, and made £800m of share repurchases too. With higher-than-expected free cash flow of £2bn in 2022, the dividend looks solid, although of course, it is not guaranteed.
I’m struggling to find a reason not to buy this stock. Management predicts solid but unspectacular sales growth between 3% to 5%. However, Citi reckons this is “conservative” and says investors should expect more.
My current investment strategy is to track down FTSE 100 stocks with higher dividends and cheaper valuations, with struggling BT Group high on my list. The troubled telecoms giant yields 5.25% and trades at just 7.21 times earnings, so fits my criteria better.
However, when I look at the solid outlook for BAE Systems, I’m wondering whether I need to gamble on BT. I might buy BAE instead.
