Image source: Rolls-Royce plc
With the benefit of hindsight, Rolls-Royce (LSE: RR.) has been one of the best UK stocks to buy in recent years. Since its lows in 2022, it has surged roughly 1,660%, turning a £2,000 investment into £35,000.
Is it still one of the best buys today though? Let’s discuss.
Significant growth potential
The outlook for Rolls-Royce is pretty exciting. Because this company is no longer just a play on civil aerospace engine manufacturing and servicing.
Today, the Footsie giant is a key player in defence – an industry that’s expected to boom in the years ahead as countries spend more in an effort to protect themselves. Here, it manufactures engines for combat jets, transport/cargo aircraft, drones, ships, submarines, and armoured vehicles.
With NATO countries set to ramp up their spending on defence from 2% of GDP to 5% of GDP by 2035, the company could see plenty of orders come in. This should help to drive revenues higher.
The other exciting part of the story is the company’s nuclear exposure. Here, it’s a leader in small modular reactor (SMR) technology (SMRs are smaller, safer nuclear reactors that can be positioned closer to the grid).
In the coming years, demand for SMRs is expected to soar due to the insane power demands of artificial intelligence, so this could be a whole new revenue driver for the company. However, there’s no guarantee that the technology will take off and even if it does, Rolls-Royce could face plenty of competition here.
Is the valuation attractive?
Of course, just because a company has an exciting story doesn’t mean that it will end up being a good long-term investment. Ultimately, investors need to ensure that they pay a reasonable price for the business.
Looking at Rolls-Royce, it does have a high valuation today. With analysts forecasting earnings per share of 32.6p for 2026, we have a forward-looking price-to-earnings (P/E) ratio of 37 at the current share price of 1,230p.
To put that into perspective, only one out of the Magnificent 7 tech stocks has a higher valuation and that’s Tesla (around 210). Nvidia – which is often considered to be expensive – has a P/E ratio of about 25.
Personally, I see Footsie company’s valuation as a little stretched. In my view, it could limit share price gains in the near term.
What do analysts think?
However, analysts don’t seem to be too concerned by it. Of the 18 brokerage firms covering Rolls-Royce, 14 see the stock as a Buy or a Strong Buy.
And recently, some analysts have been increasing their price targets. For example, yesterday (2 February) analysts at Jefferies raised their target to 1,550p from 1,290p.
That said, the average analyst price target right now is only 1,260p. That’s just 2% above the current share price.
So, while the majority of analysts believe the stock is worth buying, they don’t actually see it producing huge gains in the next year or so. That’s something to think about.
Better opportunities today?
Putting this all together, my view is that there are probably better stocks to consider buying today. I do think Rolls-Royce has a lot of growth potential but I’m not convinced that now is the best time to invest in the company.
