Image source: Rolls-Royce plc
The Rolls-Royce Holdings (LSE:RR.) share price is currently (1 October) at a level that values the group at just under £100bn.
It’s now the FTSE 100’s fifth-most valuable company. Five years ago, I don’t think many people would have predicted that. Since October 2020, the aerospace and defence group’s share price has risen close to 3,000%.
During this period, questions have been repeatedly asked (including by me) about whether the stock is overvalued. But after the company kept upgrading its earnings forecasts, I eventually took a position in the fourth quarter of 2024. I’m now sitting on a gain of around 90%. Okay, I could have done a lot better if I’d invested sooner after the pandemic. But I’m happy enough.
However, looking at three common valuation measures, I think it’s hard to deny that the shares are borderline expensive or — expressed another way — not cheap.
Crunching the numbers
For example, with a current share price of £11.90 and underlying earnings per share (EPS) of 20.3p in 2024, the group’s valued at 58.6 times historic earnings.
Looking ahead — based on analysts’ forecasts through until 2028 — its price-to-earnings (P/E) ratio drops to a more palatable 31.7.
| Year | Forecast EPS (pence) | P/E ratio |
|---|---|---|
| 2025 | 24.8 | 48.0 |
| 2026 | 29.5 | 40.3 |
| 2027 | 33.3 | 35.7 |
| 2028 | 37.6 | 31.7 |
But the trouble with the P/E ratio is that it doesn’t consider the growth rate of earnings. That’s why the P/E-to-growth (PEG) ratio was invented. It’s calculated by dividing a stock’s P/E ratio by its earnings growth rate. If the analysts are correct, Rolls-Royce will see its EPS grow by 22% in 2025. This gives a PEG ratio of 2.67. Generally speaking, a figure above one implies that a stock’s overvalued.
It’s a similar story when it comes to the group’s balance sheet. At 30 June, its accounting value (assets less liabilities) was £2.4bn. This is well below its current stock market valuation of £98bn.
Looking at these figures, I’m tempted to sell up. After all, I’m a cautious investor. However, I’m also a long-term investor. And I think there are some significant opportunities that aren’t yet reflected in the group’s share price.
Not over yet
For example, it’s leading the UK’s development of small modular reactors (SMRs). These are factory-built nuclear power stations that are designed to be assembled on site. Significant revenues aren’t expected until 2030 at the earliest. But Citi Group reckons SMRs could add 11p-40p to the share price.
The group’s boss has also said that he wants to re-enter the narrowbody aircraft market. Rolls-Royce stopped fitting its engines to single-aisle aeroplanes in 2011. If it can find a suitable joint venture partner, sales could commence by the middle of the next decade.
These opportunities complement its existing three business units — civil aviation (predominantly larger aircraft), defence, and power systems — which are growing strongly.
But there are challenges. SMRs are commercially unproven and the pandemic demonstrated how vulnerable the group can be to a downturn in the aviation industry. Its dividend is also modest, although this can be forgiven if the group’s share price continues its current rally.
Due to its lofty valuation, any sign of a weakness in the group’s earnings and its share price is likely to suffer. But I believe the long-term fundamentals of the business are solid which is why I’m going to hold on to my shares and why I still think Rolls-Royce is a stock for others to consider.
