It’s an understatement to say that holders of BAE (LSE: BA.) shares have benefited from a very volatile last few years in geopolitics. The seemingly never-ending conflict between Russia and Ukraine has pushed governments – particularly those in Europe – to increase defence spending. Donald Trump’s decision to enter a war with Iran has served to boost demand further.
As one of the biggest players in its sector, it was only natural that people looked to take advantage of these ongoing tensions. And, seen purely from an investment perspective, what a great move that would have been.
Despite this, we’ve seen a significant pullback in the last few months. From the record high hit back in mid-March, the share price has dropped around 17%. That sort of momentum is hardly insignificant. So, what gives?
Why are investors dumping BAE shares?
Based on its most recent announcements, it has nothing to do with how the business is performing.
Back in mid-February, BAE announced that operating profit for 2025 had come in at £3.3bn against £3bn the year before. Management also forecast that this would rise by 9%-11% in 2026 — a slight improvement on previous guidance. CEO Charles Woodburn’s words were particularly telling:
In a new era of defence spending, driven by escalating security challenges, we’re well positioned to provide both the advanced conventional systems and disruptive technologies needed to protect the nations we serve now and into the future.
This bullishness was further underlined when, in last month’s trading update, the company announced that it was on track to meet its earnings growth targets.
Taking the above into account, I reckon we might be witnessing some profit-taking among holders. There’s also the possibility that a few were anticipating another earnings upgrade in May. Such is the risk that comes from backing high-flying stocks.
Sure, there’s a chance that this negative momentum might continue. A merciful ending to either or both of the aforementioned conflicts could damage sentiment towards the stock, at least temporarily.
Is this company undervalued?
Let’s be clear: BAE shares still aren’t cheap, at least relative to the market. Even after taking the recent drop into account, we’re still looking at a forecast price-to-earnings (P/E) ratio of 24. Put another way, a good dollop of the very positive outlook appears to be priced in.
Then again, this valuation is actually quite reasonable among the £59bn market cap company’s peer group. Fellow FTSE 100 member Rolls-Royce boasts a huge Defence division that, among other things, supplies engines for military transport, combat aircraft, and helicopters. Its forecast P/E for 2026 stands at 34.
On this basis, BAE might actually be something of a steal.
My view
As concerning as the recent movement has been for holders, I continue to believe that this company’s astonishing order backlog means it will continue delivering for investors over the long term. And that really is the only time perspective Magpies such as me focus on. Think years and, ideally, decades; not weeks or a few months.
Given that we can always rely on there being bad actors in this world, I am strongly considering taking advantage of what appears to be a natural pullback in BAE shares rather than a frantic dash for safety.
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Paul Summers has no position in any of the shares mentioned.
