2024 was a brilliant year for investors in Rolls-Royce (LSE: RR). So was 2023. Coming into 2025, many investors may have thought that Rolls-Royce shares had limited potential for further price growth.
Time has proved them wrong – badly wrong! So far this year, the aeronautical engineer’s share price has risen by 87%.
With its latest year of strong performance, not holding Rolls-Royce shares in my portfolio means I have missed out. Should I invest now – or have I missed the boat?
Reasons for ongoing optimism
The strong rally in Rolls-Royce shares over the past few years reflects both external and internal factors – and I reckon both could potentially remain relevant into 2026 and beyond.
On the external front, the company has enjoyed a prevailing wind when it comes to market demand.
After subdued flying demand during the pandemic, civil aviation bounced back strongly. That remains the case and Rolls is continuing to see the benefit of airlines renewing and growing their fleets.
The defence industry has also seen strengthening demand, notably in Europe. I expect that to continue in coming years, which should help Rolls as it keeps growing its defence business.
The third leg in the Rolls-Royce business stool is power systems. Here too, demand is growing.
Alongside the external factor of growing customer demand, Rolls-Royce shares have performed strongly in recent years thanks to the company’s sharpened focus on its core business and improved financial discipline.
Current management has consistently set and met or exceeded specific performance targets, boosting City confidence in the firm.
Are the shares overvalued?
Still, although I see reasons to be bullish about the outlook for the company, might those factors already be priced in? After all, Rolls-Royce shares are an incredible 865% higher now than five years ago. For a mature company of its size, that is an exceptional performance.
Despite the share price rise, Rolls-Royce sells for 16 times earnings. Is that valuation a screaming bargain? I do not think so. But is it potentially still an attractive as far as I am concerned.
After all, Rolls has unique product technologies, a large installed base of engines that need to be serviced often at substantial cost and operates in an industry with long lead times and high barriers to entry.
That could potentially propel the share price even higher over the next year. The party may not be over for shareholders, even now.
I’m staying on the sidelines
But while I see reasons to be optimistic, I also think the current price offers me too little margin of safety for some of the risks. A weakening economy could hurt passengers’ willingness to buy tickets – and airlines’ willingness to shell out on costly aircraft.
We have already seen some indications of weakness in civil aviation lately, such as Eastern Airways’ collapse into administration last month.
Meanwhile, there remains the ever-present risk of a sudden unexpected downturn in civil aviation demand, as we have seen in the pandemic, following terrorist attacks and at other times.
So once again, I am looking down the barrel of a coming year and deciding not to buy Rolls-Royce shares! Twelve months from now, I will be curious to see how that decision has worked out for me!
