BAE Techniques (LSE:BA.) shares are up 70% over two years. Which means £10,000 invested then can be value £17,000 in the present day, plus round £600 within the type of dividends. Clearly that’s a return most buyers can be pleased with. Nevertheless, the query stays as as to if the FTSE 100 firm truly deserves this elevated valuation. Let’s discover.

Putin and Trump ship defence shares greater

European defence shares have surged since Vladimir Putin’s battle in Ukraine began three years in the past, ushering in a brand new period of heightened navy spending. And now President Trump’s speak of a freeloading Europe has engendered an entire new wave of defence spending.

German firm Rheinmetall is main the way in which with over 1,000% in share price appreciation. And BAE hasn’t carried out badly both, greater than doubling in worth for the reason that starting of the battle.

Nevertheless, a few of the valuations we’re seeing now exceed anticipated norms. BAE is at present buying and selling at 22.5 instances ahead earnings, which truly places it at a premium to its American friends — one thing most individuals wouldn’t have anticipated.

The present consensus forecast sees the price-to-earnings (P/E) ratio falling from 22.5 instances in 2025 to 19.8 instances in 2026 after which 18.2 instances in 2027. Whereas this isn’t a nasty charge of progress, it’s subpar in line with famed investor Peter Lynch’s price-to-earnings-to-growth (PEG) ratio.

The previous Constancy Fund supervisor stated {that a} PEG ratio beneath one suggests a inventory is undervalued. Nevertheless, BAE’s PEG ratio is 1.9. Even when adjusted for the two.1% dividend yield, the inventory seems to be considerably overvalued. Maybe by as a lot as 70%.

Enormous boundaries to entry?

Some shares can commerce with greater PEG ratios as a result of the very-long-term outlook is constructive or as a result of there are very excessive boundaries to entry of their sectors. And on that second level, defence has lengthy been thought of a sector with excessive boundaries to entry. Historically, it has been onerous to turn into a authorities contractor as a brand new entrant.

Nevertheless, I’d argue that issues are altering. We dwell in a world whereby navy supremacy shouldn’t be solely outlined by who has the most effective {hardware}, however one the place software program and small attritable methods have gotten indispensable. This has allowed new gamers to enter the market, together with the likes of Anduril, which specialises in autonomous methods. We’re additionally seeing business UAVs weaponised. The atmosphere is evolving.

This shift necessitates a re-evaluation of what constitutes a precious defence funding. It’s not solely concerning the measurement of a nation’s arsenal, but in addition concerning the agility and flexibility of its technological infrastructure. Established defence giants nonetheless possess benefits when it comes to scale and established relationships. Nevertheless, their means to innovate and combine these newer applied sciences is being challenged.

Buyers ought to, due to this fact, take into account whether or not a excessive PEG ratio is really justified for these legacy gamers, or if future progress lies with the smaller, extra nimble firms driving this technological revolution in warfare. Due to these issues, I’m not including BAE to my portfolio any time quickly, however recognize it may go greater on hypothesis about elevated defence spending.