Rolls-Royce (LSE:RR) shares have been one of the index’s stellar performers. And while I’m cautious in the near term, I reckon there’s more to come from the aerospace and defence giant over the next decade.
It could go nuclear
The small modular reactors (SMRs) programme is what excites me most. And that’s partly because the firm’s three main segment — civil aerospace, propulsion systems, and defence, are already operating towards the top end of expectations.
Back to SMRs. This technology could transform the company’s long-term prospects in ways the market hasn’t fully appreciated yet.
As countries scramble to meet net-zero targets while maintaining energy security, SMRs represent a genuinely scalable solution. Rolls-Royce has positioned itself at the forefront of this technology, and the potential market is enormous.
Of course, AI is going to be a major factor because data centres require so much energy. Global data centre energy consumption has surged to roughly 1,000TWh. That’s equivalent to the total electricity used by Japan. With a single AI query now requiring nearly 10 times the energy of a legacy search.
Rolls’ SMRs could provide a scalable programme to deliver reliable and clean energy.
Without this, I don’t see much near-term appreciation.
That’s because we’re talking about a business that’s already delivering exceptional returns. The return on capital stands at 20.4%, while the operating margin has reached 20.62%. These aren’t just good numbers — they’re excellent, particularly for an industrial company of this scale.
Where I’m cautious
Now for my concerns. At 37.9 times forward earnings (coming 12 months), this isn’t a cheap share by any stretch. The price-to-earnings-growth (PEG) ratio sits close to three, suggesting investors are already pricing in considerable future growth in the medium term at least.
That’s the compromise with quality companies — you rarely get them on the cheap.
This valuation exacerbates concerns about execution risk. Delivering on the SMR promise requires navigating regulatory approvals, securing funding, and building out manufacturing capacity. A lot of investors will be banking on Rolls being the first to commercialise the technology. But it’s a UK-based company, and I wouldn’t be surprised if British red tape allows an American peer to take the lead.
The valuation leaves little room for error. If growth projections prove optimistic or margins compress even slightly, the share price could face pressure.
My take
Despite the stretched valuation, I believe Rolls-Royce could indeed become the FTSE 100’s most valuable company. That’s based on revenue building towards £45bn in the next decade or so, with £10bn of this coming from the SMR segment.
And while I certainly believe the stock is worth considering, I’m cautious about my exposure. Personally, I’m up 350% on Rolls-Royce shares on a weighted basis, but it’s still only my 12th-largest holding. I think it’ll remain that way for now.
