Recently, the idea of owning Rolls-Royce (LSE: RR.) shares as a long-term investment has been growing on me. This is due to the fact that under the leadership of Tufan Erginbilgic, the company has transformed itself from a loss-making mess of a business into a profit machine.
Now, I’ve got capital to deploy in my Stocks and Shares ISA and SIPP so I could potentially buy the stock today. But here’s why I’m not buying the shares just yet.
Higher profits and multiple growth drivers
The increased level of profitability here has been nothing short of amazing. For example, for the first half of 2025, the group’s operating profit came in at £1,733m, up a whopping 51% year on year.
That’s not the only thing to like about the stock, however. One other key factor for me is that the group now has multiple long-term growth drivers.
For a start, there’s the defence side of the business. With many European countries set to significantly increase their defence spending in the years ahead, this side of the business could do really well.
Then, there’s the nuclear power side of the business. This appears to have huge potential because right now, both governments and private companies are exploring how they can use nuclear energy as an alternative to fossil fuel energy.
It’s worth noting here that Rolls-Royce has substantial expertise in small modular reactors (SMRs). This is a new, smaller type of nuclear reactor and the market for these is projected to explode over the next decade.
Two obstacles for me
So, why am I not buying the shares yet? Well, there are a few reasons.
One is that the share price has pretty much gone ‘exponential’ recently (it has risen from 70p to 1148p in around three years). In my experience, this kind of rise is unsustainable and often leads to a big pullback.
If earnings were to miss expectations, we could see a sharp pullback as investors reset their expectations and take some profits off the table. A 20%+ share price dip wouldn’t surprise me.
Another is that, to my mind, the valuation is stretched. Currently, Rolls-Royce has a forward-looking price-to-earnings (P/E) ratio of 41, which is higher than that of Nvidia (which is on 39)
Even if we look at next year’s earnings forecast, the P/E ratio is still 36. That’s really high.
I could probably justify a multiple of 25 or 26 here. But not 36.
It’s worth pointing out that next year, earnings per share are only projected to grow by 13% (versus 42% for Nvidia).
So, the price-to-earnings-to-growth (PEG) ratio is nearly three. That’s high and suggests that the stock is expensive relative to earnings growth.
As for revenue, that’s forecast to grow by around 10% this year. That’s a healthy level of growth but is it enough to justify the valuation? Not for me.
Other opportunities in the market
Given these valuation issues, I’m going to keep Rolls-Royce shares on my watchlist for now and focus on other opportunities in the market (and there are plenty of these). If the share price were to pull back and the P/E ratio came down to 25 or so, I could be interested in taking a position.
