What a year it was for Rolls-Royce (LSE: RR) shareholders. I mean 2023, when it was the best-performing FTSE 100 share. And 2024, when it was again among the best-performing blue chips. And 2025, come to that – so far, the Rolls-Royce share price has leapt 83% this year, despite already having had a couple of stellar years.
At this point, is the Rolls-Royce share price still a potential bargain for an industrial company undergoing a significant turnaround – or is it just a number that has increasingly lost touch with any realistic sense of valuation?
There’s clear momentum
I reckon at least some part of what is happening with Rolls-Royce shares is classic momentum.
Investors have piled in, fearful of missing out. Others have stayed out, fearing that the share is being led upwards by momentum, only to watch it keep on going — and then decide to join the party themselves, pushing the share up even further.
In this sense, I reckon there is some possible disconnection between the Rolls-Royce share price and reality.
It has climbed 1,434% since October 2022. I do think Rolls is a better business with stronger prospects now than it was then – but not to that extent!
Momentum is only one part of the story
However, while part of the story here is momentum, I think it is only part of it.
What is driving that investor craze, after all? I think a lot of it is down to the fact that Rolls is performing far better as a business than it was just a couple of years ago – and the best could be yet to come.
The current price-to-earnings ratio is 16. That is cheaper than it has been at some recent points as, while the share price has moved up, so have earnings.
In fact, they have soared. Pre-tax profit in the first half was a whopping £4.8bn, up 241% year on year. Using such a metric, the Rolls-Royce share price actually looks cheaper now than it did a year ago, even though it was lower then.
The company’s preferred metric is underlying pre-tax profit. That also went up sharply in the first half, rising 63% year on year to £1.6bn.
There could be more to come
Not only have financial results improved, so too has the outlook.
Over the past several years, Rolls-Royce has repeatedly revised its expectations upwards.
Last month, the company raised its expectation for this year’s underlying operating profit to £3.1bn-£3.2bn. Its medium-term target is even higher, at £3.6bn-£3.9bn.
Looked through the lens of ongoing earnings growth, not only does the current Rolls-Royce share price make sense – I even think it could potentially move higher from here based on business fundamentals, not just stock market momentum.
But I will not be buying.
I like the business, with its strong brand, large installed base of engine users, and ongoing growth opportunities in defence and power generation, as well as civil aviation.
But what I do not like – and more importantly do not think is reflected in the current share price – is the risk of an overnight slump in civil aviation demand eating badly into Rolls’ revenues and profits. It has happened repeatedly in the past, most recently during the pandemic. It could happen again.
So, I will not be investing.
