Why have Rolls-Royce shares fallen this week?

Rolls-Royce shares remain the best performing on the FTSE 100 over the past year, but there’s been some pullback. Dr James Fox explores.

| More on:

Image source: Rolls-Royce plc

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Rolls-Royce (LSE:RR) shares are up 178.5% over 12 months, but down 3.1% over the past week. Of course, it’s not unusual for stocks, even those on incredible bull runs, to pull back. But this was different. Rolls fell from 432p per share to 398p. That’s quite the dip. Let’s take a closer look.

Defence pull back

Shares in defence stocks fell the week beginning 8 April as analysts suggested that the sector could be getting a little crowded — too many investors taking the same strategy. European defence stocks have done something almost unimaginable over the past two years, and that’s closing the valuation gap with their American peers.

European companies, including defence stocks, have traded at a discount to their American peers for a long time. Yes, the US stock market receives more attention than the UK and European exchanges, but this premium has traditionally reflected the fact that European countries have often shied away from their 2% NATO spending commitments.

All this changed when Russia invaded Ukraine. European countries have stepped up their defence spending and they’ve also been donating lethal aid to Ukraine.

The pullback simply reflected concerns that European defence stocks might be getting a little expensive. I’d also suggest that Lord Cameron’s meeting with Donald Trump — who says he’ll stop the war in Ukraine if elected — added more fuel to the fire.

A little overdone?

In 2023, around a quarter of Rolls-Royce’s revenues came from the defence sector. The London-headquartered firm is a leading engine maker for the military transport market and the second-largest provider of defence aero-engine products and services globally. These are big-ticket items, not like ammunition and guns.

Personally, I think the selloff of Rolls-Royce stock was potentially overdone. After all, defence is by no means the company’s largest business segment and Rolls previously suggested that the war in Ukraine didn’t have a material impact on earnings. My interpretation is that Rolls benefits from broader geopolitical tensions, and long-term defence contracts, such as the AUKUS programme.


Of course, the above leads us to ask whether Rolls-Royce shares are overvalued. And in my opinion, they’re not. The civil aerospace giant is currently trading at 23.25 times forward earnings, and this figure drops to 19.2 in 2025, and eventually 16.2 in 2027 — that’s as far as the forecasts go.

This actually puts it at a significant discount to peers like GE Aerospace, which trades at 40 times forward earnings. GE’s price-to-earnings ratio falls to 31.4 times in 2025 and eventually 25.4 times in 2027. It’s substantially more expensive than its British peer.

The bottom line

Rolls-Royce is a company with a lot of positive factors and not many challenges right now. If I were being critical, I’d suggest the company is potentially too dependent on its civil aerospace unit as the pandemic — an exceptional circumstance — showed.

I, personally, still see Rolls-Royce as a stock with plenty of potential. It’s substantially cheaper than GE Aerospace and all three of its main business units — including defence — are booming.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

James Fox has positions in Rolls-Royce Plc. The Motley Fool UK has recommended Rolls-Royce Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Elevated view over city of London skyline
Investing Articles

I’m considering shares in this FTSE 250 investment trust while it’s trading at a discount

With this FTSE 250 investment trust trading at a discount to NAV, this Fool thinks it's a bargain. Not to…

Read more »

Investing Articles

If I’d invested £1,000 in Tesla stock a decade ago, here’s what I’d have now!

While many of us debate whether Tesla stock is worth the price today, it's undeniable that the EV share has…

Read more »

Investing Articles

Here’s what Michael Burry did as the BP share price dipped!

The BP share price has fallen from its peaks once again, and infamous investor Michael Burry may have spotted an…

Read more »

Young mixed-race woman jumping for joy in a park with confetti falling around her
Investing Articles

What on earth’s going on with the Barclays share price?

The Barclays share price has skyrocketed in recent months, becoming one of the best-performing stocks on the FTSE 100 since…

Read more »

Man writing 'now' having crossed out 'later', 'tomorrow' and 'next week'
Investing Articles

Analysts say this amazing FTSE 100 stock is a takeover target!

This FTSE 100 stock's one of the worst-performing companies on the index in 2024. So why might other companies want…

Read more »

happy senior couple using a laptop in their living room to look at their financial budgets
Investing Articles

5.4% yield! 2 UK dividend shares to consider for a £1,080 passive income

I think these UK shares could provide a large and sustainable passive income. And they could be great buys today…

Read more »

Investing Articles

Here’s how investing £250 a month could bag me over £10K in passive income annually

This Fool breaks down how she would go about building a passive income stream worth over £10,000 annually to enjoy…

Read more »

Young black colleagues high-fiving each other at work
Investing Articles

I’d snap this FTSE 250 stock up in a heartbeat for juicy returns and growth!

Sumayya Mansoor explains why this FTSE 250 property stock is firmly on her radar as she looks to buy stocks…

Read more »