Image source: Getty Images
Rolls-Royce (LSE:RR) shares have delivered returns beyond my wildest dreams since I first bought them in mid-2023. They’re up nearly 100% this year alone!
It has been the blistering speed of the turnaround that has surprised and delighted. I thought it might take five-to-10 years (if ever) to generate the sort of gains I’m now sitting on. Like a transatlantic flight, I was settled in for the long haul.
Looking through my holdings as we head into the new year, I’m deciding which ones I might want to add to. As Peter Lynch once said: “The best stock to buy is the one you already own“.
Is Rolls-Royce standing out as a possible candidate right now?
The incredible Rolls-Royce turnaround under CEO Tufan Erginbilgiç has centred around cutting costs, renegotiating contracts on better terms, disposing of non-core assets, and whipping the balance sheet into shape.
All of this was supported by a strong recovery in large engine flying hours following the pandemic. And rising global defence spending certainly hasn’t done any harm.
This year, management expects underlying operation profit and free cash flow to be between £3.1bn-£3.2bn and £3bn-£3.1bn respectively. Back in 2020, those figures were an operating loss of £1.9bn and a £4.2bn cash outflow.
We are continuing to progress our transformation programme, delivering profitable growth, and further strengthening our balance sheet.
CEO Tufan Erginbilgiç, Q3 2025 trading update.
Not a cheap stock
Rolls-Royce announces its 2025 results on 26 February, and some analysts expect the numbers to land at the top end or slightly above the guided range.
In November, the firm completed its £1bn share buyback programme for 2025. And before February’s report, it plans to complete an interim buyback programme worth up to £200m. So I’m not expecting any nasty surprises.
However, neither is the market, with the stock trading at nearly 36 times next year’s earnings. This strikes me as quite high. And while the dividend is now back (another sign of financial health), the forward yield sits at just under 1%. So income isn’t a big part of the investment thesis here.
Buy more shares?
Longer term, I remain bullish on the company’s growth potential. Indeed, Rolls-Royce is one of those rare companies where the prospects for each of its divisions looks strong to me.
In its core civil aerospace unit, international long-haul travel has finally surged past pre-pandemic levels. And in Power Systems, the global AI data centre buildout is creating rising demand for its backup power generators.
Meanwhile, the defence division should benefit from rising military budgets amid an uncertain geopolitical backdrop. Then there’s the exciting small modular reactor (SMR) subsidiary, which is expected to be profitable by 2030.
However, for the shares to keep rising strongly again in 2026, I think Rolls-Royce may need a beat for 2025 and stellar guidance for 2026. And these things obviously aren’t guaranteed, especially when global supply chains remain fragile.
Putting all this together, I think there are better options than Rolls-Royce for new money in 2026. Of course, if the stock sold off heavily (say 20%-30%), then I would definitely take another look.
Investors considering Rolls-Royce should be aware that the stock looks priced for perfection, even though the long-term opportunity remains attractive.
