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unfortunately do not buy BAE systems (LSE:BA) five years ago. Since then, they have grown five times more than the FTSE 100 like an everything.
BAE is an aerospace and defense contractor, and sadly their weapons are in demand these days. The stock is up 23.03% in one year and 55.69% in five years. That compares with growth of 9.57% in the FTSE 100.
I like this defensive inversion
Over five years, BAE shares would have turned a £1,000 investment into £1,557 from share price growth alone. My fag pack back calculation suggests dividends would have added another £200 or so on top of that.
For most of that time, the stock was trading at around 10 or 11 times earnings, but that was before the war in the Ukraine. BAE Systems is more expensive today, trading at 16.4 times earnings. That’s not exorbitant though, given its performance and outlook.
Results last month showed a record order intake of £37.1bn in the full year of 2022, taking BAE’s order book to £58.9bn. Sales rose 4.4% to £23.3bn, while underlying earnings per share rose 9.5% to 55.5p.
It is rare to see such a healthy set of results in these uncertain times. Even the weak pound has contributed, boosting the value of BAE’s overseas earnings once converted back into sterling. If the rest of UK plc were doing the same, we’d be in a much better place.
BAE Systems would have made me money over the last five years (and the last six months as it’s up another 17.03% in that time). But what about the future?
There aren’t many better FTSE 100 stocks
Your large order book gives me immense comfort. Defense contracts tend to be long-term relationships, so this guarantees income in the future. One potential (and hoped for) ‘risk’ is that we get some resolution to the Ukraine conflict and peace breaks out elsewhere. Frankly, I don’t see that happening. The standoff between the US and China seems more likely to intensify than ease.
Another concern is that cash-strapped Western governments will be forced to cut defense spending, hurting sales. In practice though, defense is moving up the priority list.
BAE’s dividend is not the largest of the FTSE 100. At 3%, it is well below the average yield of around 4%. However, that is largely a consequence of strong share price growth. Fortunately, the payout is covered 2.1 times by the winnings. Management has just increased the dividend by 7.6% and has also done £800m in share buybacks. With a higher-than-expected free cash flow of £2bn in 2022, the dividend looks strong, though of course it’s not guaranteed.
I am struggling to find a reason not to buy this stock. Management predicts solid but unspectacular sales growth between 3% and 5%. However, Citi believes this is “conservative” and says investors should wait for more.
My current investment strategy is to track FTSE 100 stocks with higher dividends and cheaper valuations, struggling BT group high on my list. The troubled telecom giant is yielding 5.25% and trading at just 7.21 times earnings, so it better fits my criteria.
However, when I look at the strong prospects for BAE Systems, I wonder if I should bet on BT. I could buy BAE instead.
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