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Defensive stocks are the most popular stocks with dividend investors. The predictable cost of firearms – and the stability this provides for profits – means it can be a great way to generate long-term passive income.
BAE Systems (LSA: BA ) is a defense company whose stock is in high demand today. The stock rose 46 percent as investors piled into safe-haven stocks. The conflict in Ukraine has also escalated, raising fears of a new Cold War.
BAE Systems is a stock I am considering buying to increase my own dividend income. Here, I’ll analyze the short- and medium-term dividend forecast, and explain why I’d pick it for my portfolio.
Distributed product
Let’s get the less pleasant news out of the way first. BAE Systems’ rising share price means its dividend yield to 2023 is now set at just below 3.9%. FTSE 100 Average.
The company’s yields for 2022 and 2023 are 3.3% and 3.5%, respectively.
But this flaw comes with a big caveat. The rapidly worsening economic situation means corporate earnings are coming under pressure and as a result many FTSE 100 dividends are likely to disappoint. This is not something I would expect to happen at BAE Systems.
Here the estimated dividend for the next two years is covered by double the expected earnings. Dividend coverage of 2 times and above is considered to provide investors with a wide margin of safety.
High security
Earnings don’t seem to be in any danger right now. BAE Systems’ sales at constant currencies rose 2.8%, to £10.6bn, in the six months to June. This lifted earnings before interest and tax by 4.4% to £1.1bn.
Moreover, the defense giant’s strong balance sheet should pave the way for it to meet profit forecasts despite disappointing earnings. It is so cash-rich, in fact, that it launched a three-year, £1.5bn share buyback program in July.
Why I Buy BAE Systems Shares
| BAE Systems stock price | 804 p |
| 12 month price movement | + 42% |
| Market roof | £25.2bn |
| Transfer price-to-earnings (P/E) ratio | 15.3 Time |
| Future profit rate | 3.3% |
| Split cover | 2 times |
Defensive stocks are particularly vulnerable if they experience a downturn in yields. The expensive and critical nature of the hardware you build leaves little room for error. People’s lives can be lost and the geopolitical landscape can be irreversibly changed. This could prove risky for the company’s future orders.
But encouragingly, BAE Systems has a good track record on this front. That’s why the business is the world’s seventh largest defense company by revenue, according to Defense News.
I’m buying the trade because the weapons budget looks poised to continue climbing for the foreseeable future. According to the Stockholm International Peace Research Institute, global spending will rise by 0.7 percent in 2021 and fall short of the $2 trillion mark. And I expect defense spending in the West to increase as threats to Russia and China’s foreign policy increase.
In this scenario, BAE Systems should enjoy strong and sustained dividend growth. This should allow it to continue to deliver healthy passive income to shareholders.