After a powerful multi-year rally, BAE Systems (LSE: BA.) shares have pulled back sharply, now trading near £19, roughly 20% below their all-time highs.

The question for investors is whether that dip creates a better entry point than shares in industrial rival Rolls-Royce (LSE: RR.), which have held up considerably better.

On a straightforward price-to-earnings basis, BAE Systems looks meaningfully cheaper, trading on a P/E ratio of approximately 23 based on 2026 earnings forecasts.

Rolls-Royce shares, by contrast, carry a P/E ratio of 34, making them nearly 50% more expensive on that single metric alone.

However, a P/E ratio viewed in isolation tells investors very little, and the fuller picture requires examining revenue growth, earnings momentum, balance sheet strength, and long-term potential.

BAE Systems is expected to generate revenue growth of 18% this year and 9% next, with earnings per share forecast to rise 12% and 14% respectively over the same period.

Rolls-Royce is projected to deliver revenue growth of 10% this year and 11% next, but its earnings per share are expected to surge 44% this year and a further 15% the year after.

That translates to approximately 66% earnings growth across two years for Rolls-Royce, compared to 28% for BAE Systems, a gap that goes a long way toward justifying the higher valuation.

When measured by the price-to-earnings-to-growth ratio, Rolls-Royce actually looks cheaper than BAE Systems, carrying a PEG ratio of 0.77 versus BAE’s 1.92 based on 2026 earnings growth.

On the balance sheet, Rolls-Royce held net cash of £2 billion at the end of June, while BAE Systems carried net debt of £3.2 billion, giving Rolls-Royce a clear financial advantage.

BAE Systems does retain an edge on dividends, offering a yield of approximately 2% compared to just 1% for Rolls-Royce, which may appeal to income-focused investors.

Both companies are well-positioned to benefit from rising global defence budgets over the coming years, but Rolls-Royce also operates a fast-growing nuclear division that adds a distinct long-term growth dimension.

In terms of diversification, Rolls-Royce operates across a broader range of business lines than BAE Systems, which may provide some insulation against sector-specific slowdowns.

Analyst consensus currently places average price targets for both stocks approximately 20% above their respective current share prices, suggesting the market sees comparable near-term upside in each.

Over the medium term, both companies appear similarly attractive, but on a longer-term horizon, Rolls-Royce’s earnings trajectory, balance sheet strength, and diversification may give it a slight edge for patient investors.