Babcock, Rolls-Royce and BAE Systems shares are flying again – but is it too late to buy them?

It’s been a good week for BAE Systems (LSE: BA.) shares, up 8.85%. And about time too, some of you might say. The FTSE 100 defence manufacturer has been a little sluggish lately. Despite that five-day jump, its 12-month growth totals just 12.85%.

It’s a similar story for another FTSE 100 weapons maker, Babcock International Group. But now its shares are climbing too.

Rolls-Royce (LSE: RR) is absolutely flying – but of course it’s a more complex operation. Defence only accounts for around 25% of total profits. Still, that division is doing very nicely too, and so is the share price after yesterday’s (30 July) results showed first-half revenues surging 26% to £11.3bn. Can these stocks climb higher still?

Why is this FTSE 100 sector flying?

I always feel a little uneasy bigging up the performance of defence manufacturers. Their success is a dismal sign that humanity cannot kick its warlike instincts. America is unpredictable and with Iranian missiles striking an Egyptian base in the Mediterranean, and a Russian warhead landing in NATO member Poland, today’s conflicts could spread. Let’s hope not.

The impact showed up in BAE Systems’ results yesterday. First-half underlying operating profit climbed 11% to £1.7bn. Guidance was raised too and so was the dividend, with the interim payment hiked 11% to 15p per shares. The trailing yield has crept up to 1.7%. Investors are getting dividend income as well as growth.

BAE’s order book rose again, to a record £84bn, giving long-term earnings visibility. Basically, the company has performed exactly as I hoped when I added it to my SIPP a couple of years ago. The main reason its shares haven’t gone completely gangbusters lately is that they’re expensive, with a price-to-earnings ratio of 27.2.

Are they just too expensive?

Investors have shown their pleasure by taking profits rather than buying more at today’s dizzying valuation. It’s the same story with Babcock, which has a P/E of 26.7. Its full-year results, published on 22 June, showed underlying operating profit up 19% to £433m. That’s a little misleading. It excludes a one-off £140m charge due to design changes to its troublesome Type 31 frigates.

At these valuations, evenly slightest slip could hit defence stock performance. As could any sign that the Middle East and Ukraine conflicts are easing. Building tanks, fighter jets, ships and submarines is also a tough business, and BAE, Babcock and Rolls have all had technical issues over the years. So this sector isn’t without risks. Plus of course, cash-strapped Western governments may struggle to live up to their defence commitments.

I still think BAE Systems is worth considering for investors seeking defence exposure, even at today’s price. So is Babcock. Rolls-Royce is a more varied operation, and a lot more expensive with a P/E of 47. But it’s such a stellar company I think it’s still worth considering at that price. Tentative investors could feed in money, taking advantage of any dips. Even top stocks can have them. Aim to hold them for years. Human nature isn’t about to change.

Should you invest £5,000 in BAE Systems right now?

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Harvey Jones owns shares in BAE Systems and Rolls-Royce Holdings.