It’s hard for investors to take their eyes off the Rolls-Royce (LSE: RR) share price. The FTSE 100 defence and aerospace stock’s up an astonishing 2,897% in the last five years, which would have turned a £10,000 investment into a life-changing £299,700. That’s absolutely stunning and it’s still rising at speed, up another 120% over the past 12 months.
At this rate, it’s tempting to believe the shares can defy gravity forever. But with a market cap now nudging £97bn, another 2,897% increase would take its total value to £2.9trn, roughly the size of the UK economy. I don’t think that’s going to happen.
FTSE 100 top performer
There’s no denying CEO Tufan Erginbilgiç’s transformed the business since taking charge in January 2023. He’s streamlined operations, cut debt and driven up profitability, helped by the return of long-haul flying hours and a push into areas such as mini-nuclear reactors and defence.
The obvious snag is the valuation. Rolls-Royce now trades on a price-to-earnings ratio of 57.5, which prices in a great deal of future success. I hold the stock and plan to do so for at least 10 years, but I’m realistic. Any slip in performance or delay to its nuclear ambitions could hit sentiment hard.
Its trailing dividend yield of just 0.5% isn’t much to shout about either, but as growth slows it could become a more important part of the total return. Investors looking for greater growth potential might want to cast an eye elsewhere.
Babcock’s a winner too
One FTSE 100 stock that’s been outperforming Rolls-Royce this year is Babcock International Group (LSE: BAB). Its share price has rocketed 170% over 12 months and 402% across five years, which would have turned £10,000 into £50,200. Again, it’s a growth play, with the trailing yield just 0.5%.
Babcock isn’t cheap either, trading on a P/E of 25.5, but that’s still far less demanding than Rolls-Royce. The company’s become a serious growth play in the defence sector, supplying vital engineering and support services to governments worldwide. Its £10.4bn order backlog gives it a solid base of future earnings, while a market-cap of £6.47bn leaves a bit more scope for further expansion if contracts keep rolling in.
Defence spending’s rising across Europe and beyond as global tensions escalate. Babcock calls this “a new era for defence”, and, tragically, I think it’s right. The UK’s plans for a ‘drone wall’, Germany’s rearmament, and continuing instability in Eastern Europe all point to sustained demand for the weapons makers.
Weighing the risks
No stock’s without risk. Defence orders can arrive in bursts, so any slowdown could knock confidence. Technical issues or delays could also weigh on results. Europe may drag its feet on defence spending. And while it feels unlikely today, if world tensions ease, defence firms could fall out of favour.
Still, Babcock’s momentum looks impressive, and those who feel Rolls-Royce may have peaked for now might consider buying this one instead. I’d prefer to wait for a pullback before topping up, but both firms have strong long-term stories.
The key is to stay diversified and not bet everything on one sector. A balanced portfolio remains the best way to navigate today’s unpredictable market.
