Back in January 2024, I wrote about BAE Systems as one of the best-performing names in my Coffee Can Portfolio. At the time, the stock had delivered me ~38% IRR and traded around £11.80. It looked attractively valued relative to its strong backlog, cash generation, and dividend cover. In fact I lamented that I should be bought more then it traded even lower - £7-£8 range, but I doubled down on my investment at those elevated levels too.
Fast forward to today: the stock has had a spectacular run, trading at ~£19.90, almost 80% higher than when I last wrote. Including the ~£0.35 I collected in the intervening 20 months since that post, my overall IRR has nudged up to ~50%, despite adding at the then-lamented higher price levels. This all sounds excellent on paper, but investing isn’t about celebrating past returns — it’s about assessing forward opportunity versus risk. As a portfolio constructor, we also have the additional responsibility of allocating the capital in diversified manner, with a focus on forward looking risk-reward optimisation. On those bases, I’ve decided it is time to exit.
Growth That Hasn’t Kept Pace With The Stock
Despite the share price surge, BAE’s business hasn’t evolved dramatically. Revenue grew 14% YoY in 2024, but first half of the year, the revenue went backwards, though it is expected to close 8-10% higher for the full year, 2025, and while I am happy to take that at face value, it isn’t “blowing the lights out” growth.
Profit growth is also steady but unspectacular: 2024 came in at ~£2.6Bn, with 2025 expected at £2.7–£2.8Bn — about 10% growth; Management’s own guidance now sits at 8–10%. Not bad, but hardly justifying a 28x P/E multiple.
The order book has grown from £66Bn when I last wrote to ~£75Bn today. That’s a healthy step up, but nowhere near the scale of the share price move. To put this in perspective: last year BAE traded at 0.53x order book, and today it trades at 0.76x. Investors are paying more for less incremental backlog growth today.
On one final metric, Free Cash Flow, 2025-2027 is expected to produce £5.5 Bn cumulatively. This would mean ~£1.8Bn a year, putting today’s valuation at about ~30x FCF.
Valuation Has Stretched
To be clear, BAE Systems, under the guidance of CEO Charles Woodburn, has continued to churn out impressive, steady growth as a company. So, the bear case really comes down to valuations, with a share price upgrade that has been truly spectactular.
At ~68–69p EPS, the stock is now valued at ~28x earnings, versus ~19x when I last looked and at ~30x FCF, versus ~16x previously. This is expensive territory for a Defence prime, particularly one with single-digit growth.
Dividends have inched up to 35–36p per share, but yield is now ~2% — lower than before, and not particularly compelling given the risks.
Peers Haven’t Run As Far
For context, since January 2024, Lockheed Martin (NYSE:LMT) is up ~7% and Northrop Grumman (NYSE:NOC) ~25%. Both are big US defence names with deep exposure to rising budgets. BAE has run well ahead of them — arguably justified by Europe’s incremental spending needs, but not supported by order book growth or faster revenue acceleration.
What’s Next?
As I wrote last year, defence investing is always subject to geopolitics. A “peace dividend” benefits society more than shareholders, but BAE’s recent run has priced in a level of growth that’s not visible on the books. It is very much possible that all the order book grows into massive cashflows and shareholder returns to justify current pricing, but that’s where the individual judgement comes in. If the cycle proves less durable than the market assumes, today’s multiples will look stretched. Perhaps at £14 or £15 I would be building on this position, but closer to ~£20, it feels really stretched to me.
Philosophical Bias
Let me candid here - I have a bias for the investing strategy that revolves around “protect your downside and the upside will take care of itself”. This means I am far more comfortable investing in a good company at great prices, rather than a great company at good prices. I am not exactly scuttlebutt hunting here, but there are lots of better capital upside opportunities around that I would like to pursue.
The other large theme in my investing, one that I have taken quite seriously, is to have a concentrated portfolio (ref here and here) with a small number of high conviction positions. This means that if I can’t bring myself to invest 10% of my portfolio in a position, I should think twice. Obviously I don’t have too many 10% positions today1, but it serves as a good rule of thumb for the kind of opportunities I am looking for.
The stock has been good to me - and I hope there a few more of the current lot that can get to these return levels. Given this backdrop, I’ve chosen to exit my position.
As always, happy investing!
Disclaimer: I may hold positions in the tickers mentioned in this post. I am not your financial advisor and bear no fiduciary responsibility for your actions. This post is only for educational and entertainment purposes. Do your own due diligence before investing in any securities.
Berkshire, my largest position is larger than 30% now. In addition to this, I have Harley Davidson at 10%. I also have India and China, expressed and an ETF and a 7-stock-basket respectively, coming in at 11% and ~20%. Between just these 4, I have well over 2/3rd of my capital allocation. Most of my other 2025 picks - Stellantis, Crocs and Trade Desk have the potential to be 10% each but I like to build my position gradually - matching the availability of cash from time to time. Of these Stellantis is already at 7%.