The last 12 months have been another blockbuster period of outperformance for Rolls-Royce (LSE:RR.) shares. The aerospace and engineering group has rewarded shareholders with a near-110% return since March 2024. And zooming out to when new CEO Tufan Erginbilgiç moved into the corner office, the Rolls-Royce share price has erupted by almost 800%!
But with the shares now trading at a forward price-to-earnings ratio of 37, questions surrounding its valuation are getting louder. So is the stock heading north or south from here? And if someone were to invest £5,000 into Rolls-Royce shares today, how much money would they have a year from now?
A reflection of performance
Typically, when a stock surges by near-quadruple digits in the space of only a few years, it can be a sign of unrealistic expectations. And we’ve recently seen such situations in recent years with stocks like ITM Power and Avacta. Yet in the case of Rolls-Royce, the rapid rise of its share price has actually been driven by pretty phenonmenal fundamentals.
Its full-year results for 2024 revealed a 57% jump in underlying operating profits to £2.5bn, beating management’s guidance of £2.1bn-£2.3bn. Margins climbed from 10.3% to 13.8%. And with activity within the aerospace market heating up, management’s new guidance for 2025 free cash flow puts the company on track to hit its 2027 targets two years early.
Looking out to 2028, free cash flow’s now expected to reach as high as £4.5bn, with operating margins landing between 15% and 17%. And with such a positive outlook, it’s not really surprising to see investors comfortable paying a premium for this enterprise.
Is growth baked in?
Looking at the latest analyst opinions, the overall sentiment is clearly bullish, with 12 of the 18 institutions following the company’s Buy or Outperform recommendations. But when it comes to share price targets, that’s where things start to diverge a bit.
Some analysts believe Rolls-Royce’s recent turnaround is unsustainable, with a price target of 240p. Others believe we have yet to see what the business is truly capable of with a forecast of 1,150p. But overall, the average consensus is that Rolls-Royce shares will be trading at 795p by this time next year.
That’s actually almost bang on where the stock’s trading right now. And if the forecast proves accurate, then investing £5,000 in Rolls-Royce shares today would mean investors would still only have around £5,000 in a year’s time. In other words, all the future growth expectations for this business appear to be baked into its valuation.
Forecasts aren’t set in stone. And management’s developed a knack for defying expectations these past couple of years. So if the engineering giant continues to outperform, hitting the proposed 1,150p threshold might not be completely out of the realms of possibility.
Under this scenario, a £5,000 investment today could be worth £7,100. Of course, if the momentum starts to slow, then with so much growth baked in, Rolls-Royce shares could start suffering from higher volatility. And with the risk of investors demanding perfection, I think there are other opportunities in this space to explore.
