Shares of BAE Systems (LSE:BA) have been on the rise lately. Predictably, the Russian invasion of Ukraine has boosted the stock. BAE Systems isn’t unique in this regard. Increased military activity may be a tragedy in the grand scheme of things. But it has also pushed up shares in US defence contractors Lockheed Martin, General Dynamics, and Northrop Grumman.
As the war in Ukraine ends, which we all hope it will soon, I anticipate that the BAE Systems share price will drop a little. So If I were a trader looking for a short-term opportunity, I probably wouldn’t buy BAE shares. As an investor, however, thinking about what’s next for the BAE Systems share price involves looking further into the future. Specifically, it involves trying to form a view on how the underlying business might perform over time.
I think the BAE Systems share price will be closely linked to that underlying performance. And how the business fares is in itself correlated to national defence budgets. So I see the share price and overall business moving in lockstep with each other and with those defence budgets. As I anticipate such budgets increasing steadily, I think that the BAE Systems share price will do the same.
BAE Systems manufactures ships, submarines, and fighter jets. The company’s main customers are the USA, the UK, and Saudi Arabia. I think that there’s an interesting correlation between its revenues and the US defence budget. In the last five years, US military spending has increased by around 15%, from just under $634bn in 20015 to just over $731bn in 2021. During the same period, revenue at the firm increased by around the same amount — from just over £17.7bn to just under £19.5bn.
Since the USA accounts for around 43% of sales, the connection isn’t that surprising. But it does provide evidence of just how much BAE’s prospects are tied to defence spending, especially by the US military. As far as I can tell, this is a promising sign. The US defence budget has been rising and NATO partners more generally have been increasing their defence spending in line with their commitments to allocating 2% of GDP to this area.
If this trend continues, I expect BAE Systems to do well. The company enjoys a dominant position in various important areas of national defence. Furthermore, its exposure to cybersecurity, artificial intelligence, and electronic warfare mean that it is likely to remain relevant into the future.
I anticipate a short-term decline in the BAE Systems share price. But I think that the outlook for the company is positive on the whole. The short-term impact of the conflict in Ukraine on the company’s stock might well wear off soon. Even if it does though, I think that the business will perform well over the longer term. And I also think it’s possible that the Russian invasion of Ukraine might just have a lasting effect on politicians, reminding them of the importance of the defence budget (and hopefully of the futility of war). As an investor, I wouldn’t worry too much about the possibility of an imminent drop in the price of BAE’s shares. I’d be happy buying shares for my portfolio today.
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Stephen Wright has no position in any of the companies mentioned. The Motley Fool UK has recommended Lockheed Martin. 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.