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BAE Systems (LSE:BA.) shares have made investors a lot of money over the past few years. We’re talking about a 35% annualized return over five years, almost three times FTSE 100.
Unfortunately, the first impetus for this overperformance was the horrific invasion of Ukraine in early 2022. This began a re-prioritization of European defense spending, as countries realized that major world wars in Europe were not a thing of the past.
Sadly, war may exist as long as humans exist. But the level of political instability has risen sharply in recent years, with the war in Iran that began at the end of February being the latest example.
In theory, the situation in Iran should have given BAE a boost. The Russian war really did, as did the US military operation in Venezuela in early 2026.
But since the conflict began, the defense stock of the FTSE 100 has fallen slightly. And anyone who invested £7,500 in BAE in the last 10 days will now have just £6,620 after the 11.7% adjustment.
Why is the stock low?
Even after the recent decline, BAE stock isn’t cheap, trading at 25 times this year’s forecast earnings. So investors may have been taking some profit off the table (the dividend yield is only 1.7% today).
However, another major problem is the rising prices of electricity and fuel. Not only does this location make it more expensive for BAE to produce and export equipment such as tanks, combat vehicles and artillery, it also puts pressure on cash-strapped governments.
Since the start of the Iran war, yields on sovereign debt in European countries have risen sharply. UK 10-year yields rose from 4.2% to above 5%.
In other words, UK borrowing costs have reached their highest level since the 2008 financial crisis. Where will the UK and Europe get the money to fund their defense spending targets?
This question worries the market.
I think BAE will be fine
Then again, many air defenses are coming under pressure because of the wars in Ukraine and Iran, while national security threats continue to grow around the world. So I don’t think rising bond yields have changed the growth story here.
For example, will the Gulf states want to tighten security after Iran’s drone attacks across the region? My strong suspicion is yes. The UAE is one of the most important defense partners of wealthy Gulf states such as Saudi Arabia, Qatar and the UAE.
Meanwhile, on Wednesday March 25), Turkey signed a multibillion-pound deal in London to train and support parts of its first batch of British-built fighter jets.
The defense giant ended 2025 with an order backlog of £83.6bn, for products including land, sea, air, cyber and space. The business is also well managed under CEO Charles Woodburn.
I still hold BAE shares which I first bought in 2022, and I think they will continue to do well for a long time. However, given the high valuation, I am not looking to add to my position today.
If the pullback reaches 20%–25% (around £18 per share), then I will start to get really interested. But until that happens, I see better opportunities for the FTSE 100 about.
