Rolls-Royce (LSE: RR.) shares have been a phenomenal investment in recent years. Recently, however, they’ve experienced a pullback – currently they’re trading about 12% below their highs.
Is now the time for those who don’t own Rolls to consider buying? Let’s discuss.
Firing on all cylinders
It’s no secret that Rolls-Royce has momentum today. Thanks to a brilliant transformation by CEO Tufin Erginbilgiç, the company is firing on all cylinders.
In mid-November, for example, the company told investors that it’s expecting underlying operating profit of between £3.1bn and £3.2bn and free cash flow of between £3.0bn and £3.1bn for 2025 (despite continued supply chain challenges).
Last year, underlying operating profit came in at £2.5bn while free cash flow was £2.4bn. So, profitability and cash flow are clearly heading in the right direction.
We are continuing to progress our transformation programme, delivering profitable growth, and further strengthening our balance sheet.
Erginbilgiç in November
Looking beyond this operational momentum, one thing I like about the company from an investment perspective is that it has multiple growth drivers. Not only is there the expanding civil aerospace engine market but there’s also the fast-growing defence and nuclear markets.
The latter two markets look particularly interesting to me. With NATO countries set to spend more on defence, and both governments and corporations looking to use nuclear power, Rolls-Royce should have plenty of growth opportunities in the years ahead.
An expensive stock
Of course, just because a company has growth potential doesn’t mean it will be a good investment. We need to look at its valuation.
This is where things become a little less clear with Rolls-Royce.
Because despite the recent share price fall, the company’s valuation is still very high. Currently, the forward-looking price-to-earnings (P/E) ratio is 32 using next year’s earnings per share forecast.
To put that in perspective, that’s higher than the forward-looking P/E ratios on six of the Magnificent 7 tech stocks. Of those stocks, only Tesla has a higher earnings multiple.
Given that high multiple, there’s a chance that returns from here may not be that great. Note that the dividend yield is only 0.9% so investors shouldn’t expect much in the way of income from the stock.
It’s worth pointing out that earlier this week, Jorg Stratmann, the CEO of Rolls-Royce Power Systems AG sold around £2m worth of stock. Would he have sold that much stock if he thought the share price was going higher in the near term?
Better opportunities in the market?
Weighing everything up, my take on Rolls-Royce is that it could be worth a closer look while it’s down 12%. If an investor is really desperate to get exposure to the stock, now could be the time to consider having a nibble.
But I certainly wouldn’t load up on it at current levels – the valuation doesn’t leave much room for error (eg, a slowdown in one of its markets). Right now, there are a lot of other stocks in the market that appear to have more potential.
