Rolls-Royce (LSE:RR.) shares are up a massive 620% in three years, far outperforming all other UK stocks. But while the company continues to perform well, I really don’t expect the share price to climb much further.
The price-to-earnings (P/E) ratio has now risen above 23, almost double that of the FTSE 100 average. Unless earnings improve drastically, I don’t expect that to drop soon — limiting further growth potential.
There’s no question that the aerospace engineer has enjoyed a spectacular recovery under the leadership of CEO Tufan Erginbilgiç. However, those who didn’t buy in 2024 may have missed the boat. With that in mind, I think there’s more promising growth potential in this rival FTSE 100 stock.
BAE Systems
Defence contractor BAE Systems (LSE: BA.) may lack the drama of Rolls-Royce’s turnaround, but it offers something just as important: dependable, long-term growth backed by global demand and geopolitical necessity.
The company reported a record £37.7bn in new orders in 2023, lifting its total order backlog to £69.8bn. That kind of visibility gives it a major advantage when planning for growth, investment, and shareholder returns. In contrast to Rolls-Royce, whose fortunes are closely tied to commercial aviation, BAE benefits from multi-year defence contracts backed by governments.
With ongoing global conflicts and increased NATO spending, the macro environment continues to favour defence stocks. The UK, US and European nations are all boosting military budgets, and BAE is often the provider of choice to support those needs. Recent wins include a major role in the AUKUS submarine programme and continued investment in next-generation fighter jet systems like Tempest.
Financial strength and shareholder returns
From a valuation perspective, BAE trades at a forward P/E of around 17, which looks reasonable for a company delivering steady double-digit earnings growth. It also has an excellent track record of increasing its dividend, with a compound annual growth rate of 7.3% over the past five years. The current yield is around 2%, with share buybacks adding further support to total returns.
Rolls-Royce, by contrast, only just reinstated its dividend and remains focused on deleveraging. While that may change in the coming years, BAE’s consistent capital returns are already well established.
Considerations
BAE reports in sterling but earns a large portion of its income in dollars, which adds a risk of currency devaluation. Plus, this reliance on only the UK and US governments creates concentration risk. While government contracts are usually stable and long-term, they can be delayed, renegotiated or cancelled due to shifting priorities or austerity measures.
Exposure to global markets also brings risks tied to sanctions, trade disputes and shifting defence relationships — particularly in regions like the Middle East or Asia-Pacific.
Growth without the hype
What I particularly like about BAE is that speculative recovery hopes don’t fuel its growth story — it’s based on solid fundamentals, long-term demand, and a clear strategic roadmap. The firm is actively exploring emerging technologies such as cyber defence and AI-driven military systems, offering meaningful exposure to future-oriented sectors.
There’s no denying Rolls-Royce has delivered extraordinary returns for investors who bought at the right time. But at today’s valuation, the margin for error is slim. BAE Systems may not deliver another 600% surge but for long-term investors seeking sustainable growth and a commitment to dividends, it may be the smarter pick to consider.
