How BAE Systems Measures up as a GARP Investment

LONDON -- A popular way to dig out reasonably priced stocks with robust growth potential is through the "Growth at a Reasonable Price", or GARP, strategy. This theory uses the price-to-earnings to growth (PEG) ratio to show how a share's price weighs up in relation to its near-term growth prospects -- a reading below 1 is generally considered decent value for money.

Today I am looking at BAE Systems  (LSE: BA  ) (NASDAQOTH: BAESY  ) to see how it measures up.

What are BAE Systems' earnings expected to do?

 

2013

2014

EPS Growth

9.0%

(1.0)%

P/E Ratio

9.7

9.8

PEG Ratio

1

n/a

Source: Digital Look

BAE Systems is widely expected to punch solid earnings growth in the coming year, although fears of falling defense expenditure in the West is predicted to result in a slight drop in 2014.

For this year, BAE Systems looks like great value with a PEG reading bang on the money at one, while a P/E ratio of below 10 -- territory which is generally considered decent value -- also underlines its position as a cheap pick. Next year's earnings dip knocks out this PEG ratio, however, although its P/E multiple is projected to remain in bargain terrain.

Does BAE Systems provide decent value against its rivals?

 

FTSE 100

Aerospace & Defense

Prospective P/E Ratio

16.7

12.9

Prospective PEG Ratio

4.7

3.5

Source: Digital Look

BAE Systems stacks up favorably against both the FTSE 100 as well as its peers in the aerospace and defense sector, considering both forward PEG and P/E ratios.

Many of BAE Systems' defense rivals are smaller, more flexible and thus better equipped to protect earnings despite falling expenditure on both sides of the Atlantic. Still, these problems are still a heavy plague across the whole sector, making BAE Systems look cheap at current prices.

Although fears over reduced spending from traditional customers in the near term continues to dent investor appeal, the company's huge order pipeline -- its backlog rose 8% last year to £42.4 billion -- illustrates BAE Systems' solid growth potential.

An important defense player with expanding horizons
BAE Systems is extending its geographical range in order to mitigate the effect of falling orders from the West, and saw orders outside of the U.S. and U.K. advance to £11.2 billion in 2012, a gargantuan 133% leap from the previous year. The company is already a major player in Saudi Arabia, and is making huge inroads into other lucrative developing markets including India.

The effect of budgetary constraints in Washington, combined with a reduction in combat operations in Afghanistan in coming years, is likely to crimp hardware demand from the U.S. However, BAE Systems -- which derives 40% of total turnover from the country -- remains a critical supplier to the country's armed forces.

Just this week the company, through its role as subcontractor to Support Systems Associates, was awarded a $1.5 billion contract for a five-year duration to provide aircraft engineering solutions and logistics to the U.S. armed forces.

Although fears of reduced Western spend continues to hamper confidence in BAE Systems, I believe that the company is a great GARP stock. Its position at the forefront of battleground technologies makes it an important supplier to the world's largest military superpower. Coupled with this, I expect rising exposure to lucrative new geographies to underpin strong earnings expansion moving forwards.

The expert's guide for intelligent investors
If you already hold shares in BAE Systems, check out this newly updated special report which highlights a host of other FTSE winners identified by ace fund manager Neil Woodford.

Woodford -- head of U.K. Equities at Invesco Perpetual -- has more than 30 years' experience in the industry, and boasts an exceptional track record when it comes to selecting stock market stars.

The report, compiled by The Motley Fool's crack team of analysts, is totally free and comes with no further obligation. Click here now to download your copy.

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