BAE Systems (LSE: BA.) shares have been performing very strongly lately. Indeed, since Santa came and went, the FTSE 100 stock is up 34.5%.
This means that an investor who put £10,000 into the defence giant just before Christmas would now have £13,450. And a dividend is due in early June, which would add another £178 to the return.
I mention Christmas because that’s the period when I last bought BAE shares. Mind you, it was a fair bit less than 10 grand that I invested! But it was an addition to my existing holding, which has performed very well since I initiated it in 2022.
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European defence stocks go ballistic
BAE belongs to the European defence sector and this has been on a tear recently. The rally was sparked by President Trump’s decision to pause US military aid to Ukraine. This has forced Europe into a major rethink on defence spending and security independence.
Some gains for European defence stocks have been incredible. Germany’s Rheinmetall has rocketed 112% year to date and 1,340% in just over three years! Sweden’s Saab is up 65% in 2025 and 750% over five years.
In a press statement last month, the European Commission’s president announced: “Europe is ready to assume its responsibilities. ReArm Europe could mobilise close to €800bn for a safe and resilient Europe. We will continue working closely with our partners in NATO. This is a moment for Europe. And we are ready to step up.”
Poland is expected to spend 4.7% of GDP on defence this year, up from 2.4% in 2020. However, further away from Ukraine, nations like France, Italy, and Spain want to boost military spending through grants rather than increasing their debt loads.
So, as is often the case, not all EU nations are singing from the same hymn sheet. But a future that involves massive spending increases on European-made defence systems is now almost certain.
What about BAE?
In theory, BAE should benefit from this, but it’s a bit more complex. What if the European rearmament fund largely shuts out non-EU companies like BAE? I don’t think that’s likely, but it can’t be ruled out.
Also, over 40% of the company’s revenue came from the US last year. But there is uncertainty surrounding the efficiency drive across the pond. This reliance on US contracts underscores the firm’s exposure to shifts in American defence spending policies.
Meanwhile, the UK government is committed to lifting defence spending to 3% of GDP during the next parliament, up from the current 2.3%. It aims to build a “defence industrial superpower“, though that will be a tough job given that the UK has now largely deindustrialised.
Taking stock
Therefore, it’s possible that BAE’s growth doesn’t match the lofty expectations baked into its current valuation. That is a trailing price-to-earnings (P/E) ratio of 24.3, which isn’t cheap.
I remain bullish on BAE long term though, due to its massive £77.8bn order backlog reported at the end of 2024. I have confidence that it will navigate the complexities of US and EU defence spending policies.
Therefore, I think the stock is worth considering for long-term investors. Personally though, I have chosen to build out my position on dips — like the one at Christmas — rather than going all in.
