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Deciding what to put in my Stocks and Shares ISA isn’t easy. There are over 60,000 listed companies to choose from, covering a multitude of countries and industries. But the defence sector is one that I’ve never invested in.
And this begs the question: is it ethical to try and make money from companies selling arms and other military hardware? After all, these products are designed to kill people and inflict maximum damage on property.
Conflict(ed)
Monday (24 February) was the third anniversary of Russia’s invasion of Ukraine.
And since this date, the BAE Systems (LSE:BA.) share price has more than doubled. It’s a fact that many investors have profited from the war.
With the group’s financial performance improving significantly during this period, it’s not surprising that its share price has increased so much.
Comparing 2024 with 2021 — the last full year before the war started — sales have increased by £7bn (33%), new orders are up £12.2bn (57%), and earnings per share has risen by 43%.
The company’s medium-term prospects also appear to be assured. At 31 December 2024, the order backlog was £77.8bn, nearly three times the group’s annual sales.
And with President Trump wanting NATO members to spend more on their armies, navies, and air forces, this trend could continue. Indeed, the UK government announced an increase this week.
In 2025, the company is expecting sales to increase by 7%-9%. And it’s predicting an 8%-10% increase in earnings per share. Remember, these forecasts were made long before America’s president re-ignited the debate on European defence spending.
Value for money?
But I don’t think the company’s shares are cheap. They currently trade on a historical (2024) price-to-earnings (P/E) ratio of 20, comfortably above the FTSE 100 average of approximately 14. However, it’s the same as, for example, Lockheed Martin, the world’s largest (in terms of revenue) defence contractor. Although, US companies do usually attract a higher valuation multiple than their UK peers.
And if BAE Systems can increase its post-tax profits by 10% in 2025, it implies a forward P/E ratio of 18.4. This doesn’t seem unreasonable for a rapidly growing stock.
But some investors use the P/E-to-growth ratio (PEG) to assess value for money. With a figure in excess of one, some would conclude that the stock is trading at a premium to its growth rate. In other words, it’s overvalued.
Another concern I have is that it’s heavily reliant on the US, which accounts for over 40% of revenue. I assume President Trump wants NATO members to spend more so that the world’s only military superpower can spend less.
Decision time
Personally, I wouldn’t rule out investing in the sector. I subscribe to the view that it’s the first duty of government to keep its people safe. And BAE Systems has benefitted from increased military spending by those trying to defend Ukraine from an aggressor.
Some investors distinguish between conventional and unconventional (for example, cluster munitions) weapons, refusing to fund companies making the latter. I agree with this approach. And as far as I’m aware, BAE Systems doesn’t manufacture these.
But I don’t want to invest. I think the recent share price rally means I’ve probably left it too late. And its dividend isn’t high enough — the stock currently yields 2.3% — to compensate.
