Since the middle of February, shares in defence company BAE Systems (LSE: BA) have leapt. In fact, in just seven weeks, the BAE share price is up by 30%.
The firm has niche capabilities and a solid order book at a time when defence spending in its core markets looks set to increase significantly.
Taking the perspective of a long-term investor, then, could BAE Systems shares potentially still be worth considering even at the current price?
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Valuation looks high to me
The company currently trades on a price-to-earnings (P/E) ratio of 24. That looks high to me, though it is part of a wider trend of large British defence contractors seeing their valuations increase significantly of late. Rolls-Royce, for example, is trading on a P/E ratio of 22.
The BAE share price has tripled over the past three years. By contrast, last year’s revenue was 36% higher than in 2020 and net profit was up by 50% over that period. So, while both of those numbers are impressive, share price growth far outstripped them.
That suggests to me that investors are considering the future outlook for the business when deciding what its shares are worth.
But defence is an industry plagued by cost overruns, changing briefs, and unexpected delays. So trying to understand the future prospects of a business like BAE can end up being a highly subjective activity.
Just one example makes the point: tariffs.
As new research from A J Bell and Bloomberg shows, BAE has 59% of its facilities in the US – and that single market accounts for 46% of its sales. So, shifts in US tariffs could negatively impact BAE’s profitability in a significant way.
2025 should be strong
Even allowing for that, I expect the business to perform well this year.
Its current guidance for 2025, presuming the same exchange rate as last year (itself a risk), foresees sales growth of 7%-9% and underlying earnings per share growth of 8%-10%.
I think those numbers look absolutely solid, if they are achieved. However, they are far from transformative.
Bear in mind the recent strong growth in the BAE share price as well as the P/E ratio in the mid-twenties. For me, that sort of valuation is more consistent with a company in very strong growth mode rather than one that is looking at high single-digit percentage growth on key metrics like underlying earnings per share, even as its industry undergoes a demand boom.
Meanwhile, BAE points to its “record order backlog”.
On one hand, I see that as positive: orders are flowing in. On the other hand, though, too large a backlog can be a problem for defence contractors.
The longer orders take to fulfil, the less happy customers may be – and that can be problematic not only in terms of future order flow, but also sometimes results in financial penalties.
I expect BAE to have a strong 2025 and reckon that could continue in years to come. But I think the BAE share price already builds in that expectation. For the share to move up markedly higher from here I think would take stronger news on profits or orders.
I have no plans to invest.
