Is It Too Late To Consider BAE Systems (LSE:BA.) After Its Strong Multi‑Year Rally?

• If you are wondering whether BAE Systems is still reasonably priced after a strong run, this article will walk through what the current share price could mean for long term investors.
• The stock has seen solid recent moves, with returns of 9.8% over 7 days, 12.5% over 30 days, 7.3% year to date, 66.2% over 1 year and 140.4% over 3 years.
• These price moves sit against a backdrop of ongoing interest in defence contractors, as governments around the world continue to focus on security and defence capabilities. News around defence spending plans and long term contracts often influences how investors think about companies like BAE Systems and helps frame expectations around future cash flows.
• Right now, BAE Systems has a valuation score of 3 out of 6, which means the company screens as undervalued on half of the checks we run. Next, we will compare different valuation approaches and then finish with a way to look beyond the numbers to understand that valuation in context.

Find out why BAE Systems's 66.2% return over the last year is lagging behind its peers.

Approach 1: BAE Systems Discounted Cash Flow (DCF) Analysis

A Discounted Cash Flow, or DCF, model estimates what a company might be worth by projecting its future cash flows and discounting them back to today using a required rate of return. It is essentially asking what all those future £ of free cash flow are worth in today’s money.

For BAE Systems, the model starts with last twelve month free cash flow of about £2.1b. Analysts provide detailed forecasts for the next few years. Beyond that, Simply Wall St extrapolates cash flows out to 2035 using its 2 Stage Free Cash Flow to Equity approach. By 2030, the model is projecting free cash flow of £3.6b, with each future year then discounted back to today to reflect risk and the time value of money.

Adding those discounted cash flows together gives an estimated intrinsic value of £21.43 per share. Compared to the current share price used in the model, this implies the shares are trading at a 12.2% discount, which indicates that BAE Systems screens as undervalued on this DCF view.

Result: UNDERVALUED

Our Discounted Cash Flow (DCF) analysis suggests BAE Systems is undervalued by 12.2%. Track this in your watchlist or portfolio, or discover 877 more undervalued stocks based on cash flows.

Head to the Valuation section of our Company Report for more details on how we arrive at this Fair Value for BAE Systems.

Approach 2: BAE Systems Price vs Earnings

For a profitable company like BAE Systems, the P/E ratio is a useful way to think about valuation because it links what you pay per share directly to the earnings the business is generating today.

What counts as a normal P/E depends a lot on how fast earnings are expected to grow and how risky those earnings are. Higher growth and lower perceived risk usually support a higher P/E, while lower growth and higher uncertainty tend to be associated with a lower P/E.

BAE Systems is currently trading on a P/E of 28.33x. That sits below the Aerospace & Defense industry average P/E of 50.15x, but above the peer group average of 23.02x. Simply Wall St also calculates a Fair Ratio of 31.56x for BAE Systems. This Fair Ratio is a proprietary estimate of what the P/E might be given factors such as earnings growth, industry, profit margins, market cap and company specific risks.

The Fair Ratio can be a more tailored guide than a simple comparison with peers or the industry average, because it tries to adjust for differences in growth, risk and profitability. With the current P/E of 28.33x below the Fair Ratio of 31.56x, BAE Systems screens as undervalued on this multiple based view.

Result: UNDERVALUED

P/E ratios tell one story, but what if the real opportunity lies elsewhere? Discover 1449 companies where insiders are betting big on explosive growth.

Upgrade Your Decision Making: Choose your BAE Systems Narrative

Earlier we mentioned that there is an even better way to understand valuation, so on Simply Wall St’s Community page you can use Narratives, where you and other investors attach a clear story about BAE Systems to specific forecasts for revenue, earnings and margins, link that story to a fair value, then compare it to the current price to decide whether the stock looks attractive or not right now. Those Narratives update automatically when new earnings, news or analyst assumptions come in and they allow very different views. For example, one BAE Systems Narrative ties NATO rearmament, a £75b backlog and a fair value of £21.01 to a higher future P/E of 28.38x, while another more cautious Narrative leans on the lower analyst earnings and price targets around £13.00 to justify a much lower fair value.

Do you think there's more to the story for BAE Systems? Head over to our Community to see what others are saying!

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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