As something of a pessimist, I have long been a holder of defence contractor BAE Systems (LSE: BA) shares. None of us wants to live in a dangerous world, but we do, and the company benefits from that.
This does preclude it, of course, from inclusion in some environmental, social, and corporate governance (ESG) portfolios. And this may act as a drag on the share price at some point. An easing in global tension, which we all hope for, could also do the same.
However, with the shares near an all-time high, there are two key considerations for me in continuing to hold them. The first is ‘can they go higher’, and the second is ‘what return do I get otherwise’?
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Can the shares rise?
When a stock is trading around a historical high, I focus on fundamentals. These relate both to the firm itself and to the business environment in which it operates.
In terms of the latter, the Russia-Ukraine war remains in full swing. And the longer it lasts, the higher the chance that it spreads into neighbouring regions.
Early in the conflict, BAE Systems shares rose on new orders for the F-35 fighter jets that it co-produces. The deal came from Romania, which shares a 400-mile border with Ukraine.
It was indicative of subsequent orders from European countries threatened by increased Russian aggression. Recently, these included a £1.9bn deal with Poland, and £1.6bn order from the Czech Republic.
As tensions also rose in Asia-Pacific, BAE Systems also won a key role in nuclear submarines to go to Australia.
As a result of such deals, it virtually doubled its previous earnings per share (EPS) forecasts in its H1 results.
Compared to the 5%-7% increase forecast in February, it said EPS this year would increase 10%-12%. It also lifted its sales guidance to 5%-7% growth, from February’s 3%-5%.
Positive as well for the future was the record order backlog reported of £66.2bn. This was up from £58.9bn in 2022, and from £44bn in 2021.
Also very positive for me is that government defence departments rarely cancel contracts. And they rarely quibble about rising costs either.
What return do I get otherwise?
In H1, BAE Systems’ underlying EPS rose 17% to 29.6p. It also raised its interim dividend by 11% to 11.5p per share and approved a further share buyback of £1.5bn. These suggest to me a good yield this year overall.
In 2022, it paid a final dividend of 27p, giving a yield of 3.2% — not stunning, but not bad. And shareholders also benefited from a £788m buyback.
In 2021, it paid 25.1p for a healthier 4.6% yield. And in 2020, the payout was an excellent 7.7%, based on a 37.5p final dividend.
These numbers came on top of the 45% share price rise from the beginning of 2020 to the end of 2022.
They are sufficiently compelling returns for me to keep holding the stock for its yield potential.
Increased sales and EPS forecasts, and a growing order backlog, look supportive of further share price increases, I feel.
And broader share support comes from ongoing elevated security tensions in Europe and Asia Pacific.
For these reasons, I am keeping my holding in BAE Systems and even looking to buy more shares on any significant dip.
