Image source: Rolls-Royce plc
Rising in value over 10 times to £12.87 (as of pre-market-open 13 January), Rolls-Royce Holdings (LSE:RR.) shares have been the FTSE 100’s best performer since January 2021. As a result of this rally, some argue that the stock’s overpriced and likely to fall. Others point to a number of long-term opportunities that could drive the group’s shares higher. But which is more likely to be right?
Let’s take a look at both sides of the argument.
The bullish view…
In terms of what it does and where its customers are located, the group has a well-diversified business model. Although civil aviation remains its largest division, its two others are large enough to help spread operational risk. Indeed, had it not been for the group’s defence and power systems businesses, it might not have survived the pandemic.
| Region | Contribution to revenue 2024 (%) |
|---|---|
| North America | 31 |
| Europe (excluding UK) | 21 |
| Asia | 21 |
| UK | 14 |
| Middle East & Africa | 8 |
| Others | 5 |
| Total | 100 |
| Division | Underlying operating profit/(loss) 2024 (£m) |
|---|---|
| Civil Aerospace | 1,505 |
| Defence | 644 |
| Power Systems | 560 |
| New Markets | (177) |
| Corporate | (68) |
| Total | 2,464 |
Of course, not everyone likes the idea of investing in defence. But the uncertain world in which we live means Rolls-Royce is one of the beneficiaries of increased military spending. At 30 June 2025, the business unit had an order backlog of £18.8bn.
And its move into small modular reactors (SMRs) is going well, with orders confirmed from the Czech Republic and the UK. In addition, the group’s down to the last two in a competition to develop the technology in Sweden with Vattenfall, one of Europe’s largest energy companies. However, even if everything goes to plan, it won’t be until the 2030s before significant revenue is generated.
…and the bearish view
Looking ahead, analysts are expecting earnings per share for 2025 of 28.7p. This means the stock’s trading on an eye-watering 44.8 times expected earnings. Based on the consensus for 2028, this drops to 30. This is reasonable for a rapidly-growing technology stock but appears expensive for a long-established engineering group. Which is Rolls-Royce? Probably a hybrid of the two. This makes establishing a fair valuation even more difficult.
A lofty earnings multiple makes a share price correction likely should earnings fall below expectations. This will be next tested in February, when the group’s scheduled to release its 2025 results. And the forecast dividend yield of just 0.7% is unlikely to appeal to income investors. There are plenty of other more generous dividend payers out there to choose from.
What do analysts think? Well, they have a 12-month price target is £12.50, which suggests the shares are reasonably priced. However, this is only looking 12 months ahead. In my opinion, successful investing is about taking a long term view.
My thoughts
Although I don’t think shareholders are going to see the same level of gains over the next five years as they have over the past five, I still think the stock’s one to consider. All of the group’s three principal markets look well positioned to continue growing and, looking further ahead, the SMR programme could add significantly to earnings.
Also, the firm announced its intention to return to the narrowbody aircraft engine market which, given its much larger size, could be even more lucrative than its existing aviation business with its sole focus on bigger aircraft.
For these reasons I think Rolls-Royce shares are worth considering although I reckon there are plenty of others that deserve a look too.
