The narrator describes Billy Budd, a handsome, good-natured young sailor who is taken from his merchant ship, the Rights-of-Man, into service on a British Royal Navy warship, the Indomitable (in some editions, the Bellipotent). The captain of the Rights-of-Man, Captain Graveling, tells Lieutenant Ratcliffe of the Indomitable, who has selected Billy for naval service, that he is losing his best sailor. All the other sailors love Billy and would do anything for him. Before following Billy's adjustment to life on his new ship, the narrator describes Billy at greater length. Billy is innocent and naïve, and the narrator compares him to Adam in the Garden of Eden. He has "masculine beauty" and only one flaw: a tendency to stutter when nervous.
The narrator's main story takes place in the summer of 1797, soon after a number of mutinies have beset the British navy, including the infamous Nore Mutiny. On the Indomitable, though, there was no hint of mutiny, as everyone obeys and respects the intellectual, brave captain, Captain Vere. The narrator describes the ship's master-at-arms, a man of uncertain origin named John Claggart. Aboard the Indomitable, Billy is widely admired, but often finds himself in minor trouble. He asks an older sailor, the Dansker, for advice, and he tells Billy that Claggart "is down on" Billy. Billy is confused, though, as Claggart always treats him politely. Billy is unable to see the signs of Claggart's inner dislike of him. One day, for example, Billy spills a bowl of soup in the mess hall and Claggart sarcastically congratulates him, "Handsomely done, my lad!" but Billy does not grasp the sarcasm. The narrator is unable to explain the reason for Claggart's hatred of Billy, but suggests that he was possibly envious both of Billy's handsome appearance and good moral nature.
One night, an after-guardsman wakes Billy up, wanting to speak with him in secret. He asks Billy for help and offers him two guineas. Unsure exactly what is being asked of him, Billy refuses the money. He is confused by the incident and again asks the Dansker for advice. The Dansker sees this event as confirmation that Claggart is against Billy, but Billy doesn't want to believe this, thinking that Claggart is fond of him. Meanwhile, Claggart's hatred of Billy grows. When the Indomitable is separated from the rest of its fleet after pursuing an enemy vessel, Claggart goes to Captain Vere and tells him that he suspects Billy Budd of plotting mutiny. Captain Vere is inclined not to believe Claggart, as he admires Billy's good behavior and handsome demeanor. He sends for Billy so that he can get to the bottom of the matter.
Captain Vere, Claggart, and Billy meet in the captain's cabin. Claggart repeats his accusation, and Billy is so stunned that he is unable to speak. He tries to speak and gesture violently, but his stutter stops him, and he ends up striking Claggart in the head. Claggart drops to the floor, dead. Captain Vere assembles a drumhead court and puts Billy on trial, hoping to resolve the matter quickly and privately, in case widespread news of Billy's deed might cause dissent and the beginnings of mutiny on the ship. Captain Vere and his court are troubled and conflicted, forced to decide between maritime law, which would call for Billy's execution, and their personal moral scruples and fondness for Billy. The court interrogates Billy and he tells them that he did kill Claggart, but not intentionally, and that Claggart was lying: he was not plotting mutiny. Captain Vere and the others believe Billy, who is taken away from the room so that the court can reach its verdict. Captain Vere insists that, although the court may have personal moral feelings in favor of Billy, they must make a decision based solely on the law and on Billy's actions. The court ultimately sentences Billy to execution.
The ship's chaplain visits Billy the night before his execution, but can scarcely say anything helpful, as Billy seems at peace with his fate and entirely innocent. The next morning, the crew of the Indomitable is called to deck to witness the execution and Billy is hanged. His body hangs perfectly still and is illuminated by the morning sunlight, as if in a "mystical vision." Days later, the ship's surgeon and purser debate whether the stillness of Billy's body during execution is proof of Billy's exceptional will power. Regardless, after Billy's death the captain orders everyone to return to work.
The narrator apologizes that he cannot offer a nice or symmetrical ending to his story, as is found in fictional tales, because he is giving a true account of actual events. He tells of Captain Vere's later death in combat. Just before dying, Captain Vere says his final words: "Billy Budd, Billy Budd." The narrator says that the only record of Billy's death was in a naval chronicle, which wrongly reported the story, claiming that Claggart had alerted the captain to the evil plotting of Billy, who had then cruelly stabbed Claggart to death. Finally, the narrator describes how the sailors of the Indomitable remembered Billy favorably, and memorialized him in a song that became a well-known ballad, "Billy in the Darbies." The narrator ends his story with the text of the ballad, which sympathetically narrates Billy's final moments.