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Over the past five years, Rolls-Royce (LSE:RR) has absolutely demolished all other FTSE 100 shares. And it’s not even close, with its 1,200% return more than double that of runner-up Babcock International (+525%).
Yet despite this truly incredible performance, no investment is perfect. And it’s always important to look at a stock dispassionately.
With this in mind, let’s take a look at Rolls-Royce in terms of the good, the bad, and the unknown.
Things look on track
The good clearly centres around the firm’s incredible financial performance. In November’s market update, management confirmed that the engine maker was on course to deliver full-year underlying operating profit of £3.1bn-£3.2bn and free cash flow of £3bn-£3.1bn.
Crucially, this was in spite of persistent supply chain challenges across the aerospace sector.
Looking ahead, UBS reckons free cash flow could hit £5.6bn in 2028, slightly higher than the market expects. The bank estimates both the Civil Aerospace and Power Systems divisions will see noticeably higher margins by then.
As a result, analysts at UBS have a 1,625p share price target, which is 34% above the current level. Most other analysts are still bullish on the stock too.
So the good news here is that Rolls-Royce is performing well despite the supply chain challenges, and is excepted to become significantly more profitable over the next few years.
Looking further out, the company’s small modular reactor (SMR) business has a massive growth opportunity. According to the International Energy Agency, there could be as many as 1,000 SMRs worldwide in 24 years’ time.
Finally, the company’s balance sheet is in much better shape, supporting dividends and ongoing share buybacks.
Priced for perfection
The negative side of the investment case here is that the stock is highly valued. That is, much of the future growth from higher engine flying hours and rising defence spending appears already baked in.
That’s because the forward-looking earnings multiple is 37. While this doesn’t prevent the share price from heading higher, it does leave little margin for error. Even slightly disappointing 2026 guidance in the firm’s next update in late February could spark a big sell-off.
As mentioned, there are also challenges bubbling away in the background. Plane maker Airbus has flagged ongoing industry-wide supply chain pressures throughout 2026.
And some unknowns…
One unknown is when the company will firmly commit to re-entering the narrow-body (short-haul) engine market. According to Airbus’ latest global forecast, 34,250 new single-aisle aircraft will be needed between 2025 and 2044 to meet surging travel demand.
Clearly then, this is another massive potential growth opportunity. Rolls-Royce has said it intends to re-enter this market via a partnership, but we don’t know the details on this yet. How much will it cost?
Another unknown is how long CEO Tufan Erginbilgiç will stick around for. The board has just handed him a big pay boost, and there’s no suggestion that he’s thinking about leaving. But Erginbilgiç retiring or leaving would be a big blow. Who could fill his shoes?
Summing up then, there are a few different things for investors consider about Rolls-Royce shares. In the long run, the company’s growth prospects still look very strong, but the stock might be overvalued at the moment.
We’ll find out more when the engine maker reports 2025 earnings on 26 February.
