Rolls-Royce (LSE:RR) shares had a remarkable 2023, delivering growth in excess of 200%.
Some investors may be skeptical about investing in a company that has already seen such rapid share price growth.
But that might not be the case with Rolls-Royce. Currently, analysts have eight ‘buy’ ratings, four ‘outperform’ ratings, and six ‘hold’ ratings. There are no ‘sell’ ratings.
The stock even appeared on Steven Cress’s top 10 stocks of 2024 — the only UK entry.
So, why are so many analysts and investors bullish on this stock? Let’s explore.
A diversified, defensive business
Rolls-Royce has four business segments. These are civil aviation, defence, power systems, and new markets — the latter doesn’t contribute to earnings.
While I’ve previously suggested Rolls might be overly dependent on its civil aviation business, it’s more diversified than many peers in the market.
The defence segment is flourishing, primarily due to regional conflicts and rising defence budgets globally.
At the end of the first half of 2023, the order backlog for defence was £8.9bn (around 2.5 times forecast 2023 revenue), up from £8.5bn at the end of 2022.
Meanwhile, the power systems segment had an order backlog worth £3.9bn (around one times 2023 expected revenue).
However, the most significant developments have been in civil aviation.
The sector has rallied from its pandemic-era nadir and analysts now expect more than 40,000 aircraft to be ordered within the next two decades.
This is a very important trend, but it’s worth noting that only 20% of these 40,000 aircraft will be wide-body jets. And Rolls’s large energy-efficient jets are used on wide-body aircraft.
And despite talk of re-entering the narrow-body market, that’s not likely for a decade. This is certainly something to bear in mind.
Nonetheless, the segment is booming. The large engine order book reached 1,405 engines at the end of H12023, equivalent to more than three years of deliveries at 2023 production rates.
One concern may be the recently reduced investment in new markets. That could limit growth in the long run.
Still value
Valuation metrics should be central to every investment decision. These key indicators provide crucial insights into the financial health and potential growth of a company.
Metrics such as price-to-earnings (P/E) ratio, price-to-sales ratio, and dividend yield offer valuable perspectives for investors, guiding them in assessing a stock’s attractiveness and its alignment with their investment goals.
In the below table, I’ve detailed forecasted earnings per share figures for the next three years, and created P/E ratios accordingly — using the share price.
| 2023 | 2024 | 2025 | |
| EPS | 8 | 10.6 | 14.2 |
| P/E | 38.3 | 28.9 | 21.4 |
Of course, these figures are contextual. While the forward P/E for 2023 looks expensive versus its peers including RTX Corp and General Electric, moving to 2025, it broadly trades in line with its peers.
However, it’s on growth that Rolls-Royce looks exceptionally good value, and we can assess this using the price-to-earnings growth (PEG) ratio.
Over the next three-five years, analysts expect to see Rolls’s EPS increase by 71% annually — with the majority of that seemingly coming toward the end of the range.
In turn, this leads to a forward PEG ratio of 0.47, inferring the stock could be 53% undervalued. And this is exactly why I re-added Rolls to my portfolio last month, and why no analysts have ‘sell’ ratings.
