Are investors running scared of Babcock and BAE Systems shares?

BAE Systems (LSE: BA) shares have unsurprisingly surged on the back of rising geopolitical tensions. They’re up 37% over the last year and 360% over five years. Another FTSE 100 defence stock, Babcock International Group (LSE: BAB), has done even better. Over the same periods, it’s up 73% and 410%.

Both look like obvious go-to stocks as Middle East tensions escalate further. Yet anyone expecting them to be flying right now will be in for a surprise. BAE Systems and Babcock have both slipped over the last week, in Babcock’s case by 7.5%. So what’s going on?

Booming FTSE 100 sector

It certainly isn’t because tensions are easing. The FTSE 100 is in correction territory having dropped more than 10% since Iran tensions exploded. It’s plunging today as energy infrastructure comes under threat, raising the risk of an oil price spike or even shortages. More countries risk being drawn into conflict. Yet defence stocks are drifting.

Markets never move in straight lines, and neither do individual shares. Even in bull markets or crashes, there are pauses. That may be part of it. But there’s more going on.

Valuation is an obvious issue. After such powerful runs, both stocks look expensive. BAE Systems’ price-to-earnings ratio is pushing towards 30, well above the FTSE 100 average of around 17. Babcock isn’t far behind.

There may also be a technical factor at play. After such strong gains, some investors may be taking profits and rotating into sectors that have been left behind. With many FTSE 100 stocks now trading at bargain valuations, capital is being redeployed. That may have knocked demand for defence stocks, even while the underlying story remains intact.

Both still have plenty to offer. BAE Systems’ full-year results in February showed underlying operating profit up 12% to £3.32bn in 2025, beating forecasts. Its order backlog hit a record £83.6bn, while net debt fell 22% to £3.84bn.

Babcock’s latest full-year results, published in November, saw underlying operating profit up 19% to £201m, with a contract backlog of £9.9bn.

Investors chasing bargains

Investors may be waiting for the next catalyst before pushing shares higher. Fresh results or major contract wins would help. Government spending is another factor. The UK faces pressure to increase defence budgets, but is short of cash. The same dilemma applies across Europe, with the exception of Germany. Politicians may prioritise competing demands such as protecting households from rising energy costs.

If governments do commit to sustained increases in defence spending, or if tensions escalate further, the sector’s earnings visibility would strengthen. That could draw investors back in.

The defence rally has already priced in a lot of good news, and it’s struggling to push to the next level. At current valuations, it’s easy to see why investors are cautious. I’m wary myself. I hold BAE Systems shares and wouldn’t dream of selling them. But I’m looking elsewhere for my next opportunity. There are so many bargains on the FTSE 100 today, I hardly know where to start…

The post Are investors running scared of Babcock and BAE Systems shares? appeared first on The Motley Fool UK.

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Harvey Jones has positions in BAE Systems. The Motley Fool UK has recommended BAE Systems. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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