BAE Systems has been the best way for UK-focused investors to position their portfolios for increased defence spending in response to increased aggression by Russia.
Indeed, the BAE Systems share price has tripled since Putin rolled his tanks into Ukraine in February 2022.
However, there is mounting evidence to suggest the share price has gotten a little ahead of itself from a valuation perspective, and investors should consider the medium-term performance of the stock from elevated levels.
With the prospect of peace in Eastern Europe looking just slightly more likely after Trump met separately with Putin and Zelenskyy this week, the defence spending trade could become less attractive, making companies such as BAE vulnerable to selling.
Throw into the mix an earnings multiple that puts the stock on the highest valuation for nearly two decades, and BAE Systems shares look set for a correction.
BAE Sysems’ recent performance
Beyond the geopolitical situation and high valuation, there are plenty of positives to take away from the group’s recent half-year report.
BAE Systems secured £13.2bn in new orders during the first half of 2025, with all segments enjoying higher order flows. The company closed the period with a substantial order backlog of £75.4bn, providing exceptional revenue visibility and underpinning future cash generation.
This backlog, combined with programme incumbencies on long-term contracts, supports BAE’s value-compounding business model and offers investors predictable earnings growth.
Key successes stories include Typhoon combat aircraft, Type 26 frigates, Dreadnought submarines, electronic warfare systems, precision munitions, and space-based capabilities. BAE’s participation in strategic programmes like GCAP (Global Combat Air Programme), AUKUS submarine development, and the US Golden Dome project positions the company to capture significant long-term contracts.
However, for all the predictability of cash flows and heightened demand for arms, earnings growth hasn’t exactly wowed investors.
First half revenues grew 11% and EBIT rose 13%. While these are solid numbers for a firm of BAE’s scale, they don’t seem high enough to justify a valuation of 25x historical earnings.
For many years, BAE Systems traded between 10x -16x earnings. The current 25x multiple is an outlier.
Forward earnings on analyst estimates fall only modestly to 22.5x earnings.
Earnings will continue to be underpinned by higher defence spending plans. NATO members agreed to increase defence investment to 5% of GDP—a significant jump from the previous 2% benchmark.
However, it appears the market has already priced in many years of increased defence spending and BAE profit growth, which isn’t a 100% certainty, making BAE Systems vulnerable to profit-taking.
You can afford BAE Systems a higher valuation than historical averages due to the likelihood of geopolitical tensions persisting in the years ahead.
But 20x earnings seems more sensible than 25x. This would put BAE Systems shares back down to 1,360p.