As Rolls-Royce and Babcock rocket, has the BAE Systems share price finally run out of juice?
The BAE Systems (LSE: BA) share price has enjoyed an astonishing run. As the company is Britainâs leading defence manufacturer, thatâs hardly surprising. Geopolitical tensions continue to escalate, with the world entering a new arms race.
The Iran conflict has taken things up another notch, pushing defence stocks higher still. Theyâve provided valuable diversification for investors, me included, at a time when many other holdings have been hit by events in Iran.
BAE Systems shares are up 40% over the last year and 335% over five years, with dividends on top. Itâs a remarkable performance. Long-term investors will be delighted, even if the circumstances driving those gains are less welcome.
Given recent events in the Middle East, investors might expect BAE Systems shares to have surged over the past month. But theyâve been broadly flat.
The FTSE 100 is flying today
Why? Valuation could be one reason. With a price-to-earnings ratio nudging 30, some investors may feel thereâs limited upside left in the short term. Iâve held the shares for several years, and while performance has been strong overall, there have been periods of consolidation as investors wait for the next leg higher. Shares rarely move in a straight line.
Itâs also worth comparing BAE with its smaller FTSE 100 peer, Babcock International Group. Long-term performance there has been even stronger, with the shares up 60% over the past year and more than 400% over five years. Yet, interestingly, Babcock shares have fallen 16% over the past month. Similar forces may be at play. Like BAE shares, they no longer look especially cheap.
Thereâs also a broader question. While Western European countries are under pressure to increase defence spending, can they really afford to, given the strain on public finances? Weâre seeing that domestically. The UK government faces calls to lift defence spending to 3% of GDP, but progress has been slow, frustrating suppliers. Politicians are not exactly flush with cash these days.
This morning, the FTSE 100 is up 1.75% on hopes of easing tensions in the Middle East. Among the biggest risers is Rolls-Royce Holdings, which also has defence exposure. Its shares are up 6.8%. Babcock is close behind, rising 5.5%.
Defence stocks still in demand
Thatâs slightly surprising. I would have expected defence stocks to fall on peace hopes. Perhaps this suggests investors believe uncertainty will persist, particularly if Iran retains control of the Strait of Hormuz. Add in concerns about the future of NATO, with Donald Trump raising doubts about his commitment, and the case for sustained European defence spending remains strong.
Despite this, BAE Systems shares have edged up just 1%. Theyâre not fully participating in the latest rally. Again, valuation may be the sticking point. BAE offers reliable revenues and a substantial order book, providing strong earnings visibility. But after such a powerful run, the shares may simply need time to consolidate.
That doesnât diminish the long-term story. I still see BAE Systems as a high-quality, core holding. However, in the short term, investors might consider holding back. There are plenty of exciting growth opportunities elsewhere in the FTSE 100. Despite this morningâs bounce, I think many still look attractively priced.
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Harvey Jones has positions in BAE Systems and Rolls-Royce Plc. The Motley Fool UK has recommended BAE Systems and Rolls-Royce Plc. 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.
