Few UK shares have delivered a comeback story as spectacular as Rolls-Royce’s (LSE:RR.). After flirting with bankruptcy following the pandemic, a new leadership team fundamentally transformed the business into a global engineering titan that now trades at a record high valuation.
Anyone who bought the shares in February 2021 for less than £1 has gone on to earn a 1,239% return. And for those who reinvested the group’s recently reinstated dividend, have already expanded this gain to 1,256%.
In terms of money, a £10,000 initial investment is now worth £135,600!
The question now is, can Rolls-Royce shares do it again?
What’s next for Rolls-Royce?
With its market cap now sitting at £105bn, investors expecting another near 1,300% return on investment by 2031 are likely to be left disappointed. After all, that would put the group’s market capitalisation at over £1.4trn – one of the highest in the world.
However, while a quadruple-digit gain looks unlikely, that doesn’t mean the growth story is over.
A combination of higher global defence spending, a civil aerospace aftermarket services boom, and steady aircraft fleet modernisation trends has culminated in a multi-year supercycle for the aerospace sector.
At the same time, management has expertly positioned the business to potentially be a top dog in the emerging small modular reaction (SMR) energy market. And with the ongoing build-out of new AI data centres, as well as adoption of other energy-hungry technologies like electric vehicles, Rolls-Royce could be on track for superb growth next decade.
With the business having already hit its 2027 turnaround targets two years early, management has proven its skill at execution, even in a challenging economic and supply chain environment.
So, does that make Rolls-Royce shares a no-brainer?
What to watch
The company’s outlook is undoubtedly exciting. However, even a terrific business can still be a terrible investment if the wrong price is paid. And with the stock now trading at 40 times forward earnings, it seems investors are already pricing in future gains from its SMR technology.
This assumption of success might be a bit too ambitious.
There’s no denying that Rolls-Royce is near the front of the pack, especially after securing its preferred bidder status with the UK government. But grid connections aren’t expected to materialise until the mid-2030s. And that’s assuming no project delays in a highly regulated area, or that rival engineering groups don’t innovate better alternative designs.
What’s the verdict?
As much as I admire this business, its current valuation doesn’t present as a compelling risk-to-reward ratio in my mind. Right now, Rolls-Royce shares are seemingly being priced for perfection. As such, the slightest operational speed bump could be all that’s needed to trigger widespread profit taking.
In other words, at a better price, this stock looks compelling. But right now, I think investors should consider looking elsewhere for investment opportunities. Luckily, there are plenty of potential winners to choose from.
