There’s no denying that Rolls-Royce (LSE:RR.) shares have been a key driver behind FTSE 100 growth in the past few years. The stock price has gone parabolic and continues to climb despite growing fears of a correction.
But here’s the puzzle that’s keeping savvy investors awake. Despite surging 111% in the past year, earnings have grown eight times faster than the share price. On the surface, that sounds brilliant — a company printing profits while the price lags. But dig deeper, and you’ll find a somewhat more complex situation unfolding.
In my opinion, the numbers tell a conflicting tale. Underlying operating profit and cash flow are expected to exceed £3bn in FY25, while engine flying hours have recovered to 109% of pre-pandemic 2019 levels. Meanwhile, earnings per share (EPS) nearly doubled in H125, so there’s no questioning the company’s exceptional performance in recent years.
So why the worry?
Here’s where it gets uncomfortable. Those impressive profits are now capitalised into a forward price-to-earnings (P/E) ratio of 41.7, nearly triple the company’s historical average. The average 12-month price target sits at just 7.8% above today, remarkably muted for a stock that’s up 111% in a year. Investors, it seems, have priced in the recovery – there may be little left to surprise them.
For retirement-focused investors accustomed to FTSE 100 dividend stocks yielding 5%-7%, Rolls-Royce offers almost nothing. The current dividend yield sits at a negligible 0.87%, with forecasts of 10.6p per share in 2026 and 12p in 2027. Even at these higher levels, the yield barely ticks above 0.8%-1%. To generate meaningful income, you’d need to hold a substantial position — which seems risky given the current valuation.
Then there’s the matter of £4.9bn in debt weighed against £2.4bn in equity. Despite a net cash position of £1bn, the debt load remains substantial. Plans to deliver £1bn in share buybacks by the end of 2026 are arguably optimistic given the valuation risks ahead.
So what’s the play?
I can hark on about overvaluation and debt all day but that doesn’t mean Rolls’ share price won’t keep climbing. Strong cash flow, a stacked order book, and robust market sentiment are enough to support an ongoing upward trajectory.
But the longer it continues, the longer it becomes a price balanced on an increasingly fragile foundation. Not by any fault of the business itself but simply by the laws of economic sustainability. With a share price down 7% in the past two weeks — the third such instance in a year — investors are understandably worried.
So for those willing to take a risk on the long-term growth narrative, Rolls is still worth considering. However, for more value-focused and risk-averse investors like myself, it’s unlikely to appeal.
Fortunately, the FTSE 100 is brimming with high-quality, lower-valued options that are forecast for exceptional growth in 2026. For investors seeking stable returns without the high valuation risk, RELX, Experian, and London Stock Exchange Group deserve a closer look right now.
Whether you choose the route of income stability or high risk/high reward growth, it always pays to maintain a broadly diversified portfolio. Structuring a portfolio with a variety of stocks from various sectors and geographical regions helps to reduce risk while targeting a mix or market opportunties.
