At the start of July, BAE Systems (LSE:BA.) shares were toiling. They’d fallen 21% since mid-March, with investors questioning whether the multi-year defence stock boom had finally ran out of steam.

I didn’t buy into this. In fact, on that very day, I wrote: “I think the long-term investment case here remains very strong. And…I actually think BAE’s dip is worth considering buying”.

However, I didn’t envision such a sharp recovery, with BAE stock now up 20.4% since the start of July. That’s enough to have turned a £5,000 investment into £6,000 (excluding costs).

What’s behind this sudden revival?

A trio of catalysts

Three catalysts stand out. First off, John Healey — the previous defence secretary who had quit after saying the government was moving too slow on defence spending — was appointed as the new chancellor.

This was seen as positive for UK military spending. Note, roughly 28% of group revenue comes from the UK.

Next, BAE reported strong half-year earnings on 30 July, including upgraded full-year guidance.

Finally, there has been a covering of short positions across the defence sector, according to data from Citi. So this has also likely helped the rally.

Rock-solid fundamentals

In the first half, sales grew 9% on a constant currency basis to £15.8bn, with all divisions contributing positively. Underlying operating profit rose by 11% to £1.7bn, while FCF of £1.8bn came in higher than expected. 

BAE took in £16bn worth of orders, taking the order backlog to a record £84bn. And CEO Charles Woodburn said the strong balance sheet gives the group “real strategic flexibility”.

The interim dividend was hiked 11%. And while the forward yield of 1.92% might not turn heads, and payouts are never guaranteed, BAE boasts a record of 22 years of dividend increases.

Strong coverage and multi-year revenue visibility suggest attractive dividend growth moving forwards.

Global growth opportunities

Across the globe, our growth opportunities are significant.
Charles Woodburn.

Without wanting to sound like a broken record, the investment case still looks very strong here for me. Military spending in the UK and particularly in the US is set to increase well into the 2030’s.

Moreover, the geopolitical situation in the Middle East is almost certainly going to drive higher defence spending in the region. And beyond oil-rich Gulf customers, BAE sees both Japan and Australia as big potential growth markets (due to fears about the threat from China).

Canada, which recently joined the Global Combat Air Programme as an observer, is another emerging market. It has already committed to NATO’s 3.5% target by 2035.

These are additional growth opportunities beyond Europe, which now accounts for 33% of the total order backlog after sales surged 30% in the first half. Crucially, as mentioned, BAE has the financial muscle to invest in all these opportunities.

Admittedly, the forward earnings multiple of 24 is noticeably higher than the 10-year average of about 15. This adds risk if growth disappoints or there are equipment quality setbacks.

But the commercial opportunity is also significantly larger than in the past, justifying a premium valuation, in my opinion. Looking at the bigger picture, I think BAE shares are still worth considering.

Should you invest £5,000 in BAE Systems right now?

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And right now, Mark thinks there are 6 standout stocks that investors should consider buying. Want to see if BAE Systems made the list?

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Ben McPoland owns shares in BAE Systems.

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