The Rolls-Royce (LSE:RR) share price has surged because it’s a quality company delivering unexpected good results over a surprisingly long period of time. This has rightly caught the eye of UK retail investors who have been very keen to get a piece of the action.
However, stocks can’t sustain this momentum forever. And while I’m not saying Rolls-Royce shares won’t go up from here, there’s certain some evidence that the stock’s trading closer to fair value than it has at any point over the past three years.
So how do we know it’s closer to fair value? Well, here are a few signs.
Firstly, it’s trading with a forward price-to-earnings ratio of 44. In other words, investors are willing to pay £44 for £1 of earnings. That’s a lot higher than the index average, around 15 times.
And while the company’s expected to deliver really impressive earnings growth throughout the medium term, the stock’s price-to-earnings-to-growth (PEG) ratio is 2.6. This is much higher than the typical threshold for good value. In fact, the sector average is 1.83.
What’s more, it’s also trading slightly above its average price target. This suggests analysts believe the stock should be worth slightly less than it’s trading for. However, institutional analysts really aren’t all they’re cracked up to be.
Still an amazing company
As an investor, I want to buy great companies, ideally at the right price. And Rolls-Royce is certainly a great company. Why is that?
Rolls-Royce boasts a powerful economic moat built on technology, scale, and customer lock-in. The firm’s engines power roughly half of all widebody aircraft worldwide, giving it strong switching barriers and long-term visibility.
This technological leadership extends to other segments including defence and now nuclear. Heavy R&D spending — £1.3bn in 2024 — further strengthens its technological lead, while it remains diversified with several high-margin income streams.
Valuation hits limits
However, much of Rolls-Royce’s outperformance in 2025 reflects the strength of global travel demand. Consumer intent for travel remained near four-year highs as of July, despite inflation and a tightening labour market.
This momentum directly benefits Rolls-Royce’s ‘Power by the Hour’ model, driving H1 2025 revenue up 10.6% to £9.1bn and operating margin to 19.1%. Civil Aerospace led the rebound, achieving an impressive 24.9% adjusted margin amid strong aftermarket demand.
Investors have also been getting very excited about the firm’s positioning in the small modular reactor sector. However, there comes a point when we have to ask ourselves whether the company’s operational trajectory can support more positive price action.
My belief, as a shareholder in Rolls-Royce, is that we will see some steady growth when annualised over the long run. However, for now, there may be clearer value opportunities elsewhere on the market.
I’ve frequently spoken about Rolls-Royce’s peer, Melrose, which I believe is still undervalued despite a 57% jump over the past six months. The market remains full of opportunities for investors who are willing to do the research.
I believe Rolls-Royce shares are worth considering, but other stocks are worthy of more consideration!
