Rolls-Royce (LSE: RR) shares are down 14% from their 26 February one-year high of £14.09. But this looks to me like an extended bout of profit-taking rather than a verdict on the core business. After all, the stock’s risen a stunning 1,161% since Tufan Erginbilgiç became CEO in 2023.
With new orders flooding in, margins expanding, and cash flow running at structurally higher levels, the business looks set for strong growth ahead. Rolls-Royce is also benefiting from a leaner cost base, stronger pricing power, and a defence arm delivering rising, high‑quality earnings.
Consequently, this rare pullback in price looks like an unmissable opportunity to build my position at a lower price.
How does the growth momentum look?
Sustained earnings momentum drives a company’s share price higher over time, and Rolls‑Royce continues to deliver it. A risk here is any prolonged supply‑chain constraint that slows engine servicing, and another is any unexpected downturn in large‑engine flying hours.
Even so, underlying operating profit soared 41% year on year to £3.5bn, highlighting the group’s operational transformation and commercial optimisation. Operating margin expanded from 13.8% to 17.3%, illustrating the structural uplift from efficiency and simplification initiatives.
Free cash flow surged 35% to £3.3bn, underlining the strength of aftermarket profitability and long‑term service agreement growth.
As a result, management upgraded mid‑term targets to £4.9bn-£5.2bn operating profit, 18%-20% margins, and £5bn-£5.3bn free cash flow by 2028.
Together, these elements mean the business now has far greater earnings power than at any point in its modern history.
How undervalued are the shares?
Because price and value are not the same measure in financial assets, a stock can still have much value left in it even after a big price rise. This is because value relates to a range of underlying business fundamentals. But price is just a function of supply and demand in the market at any given time.
Illustrating this point perfectly is Rolls-Royce. Despite the stock’s huge price gain over three years, it is still bottom of its competitor group on the key price-to-earnings ratio. Its rating of 16 is very cheap against the peer average of 28.8. These firms consist of Northrop Grumman at 17.9, BAE Systems at 29.3, RTX at 32.3, and TransDigm at 35.9.
Moreover, the mean average one-year target price of the 19 analysts covering the stock is £13.99. That is 16% higher than where the stock trades today.
All of this points to a company whose valuation still has not caught up with its transformed fundamentals. And when price lags value by this much, it usually creates a great opportunity for savvy long-term investors.
My investment view
As a long-term investor, and hopefully a savvy one, I cannot pass this opportunity up. I initially bought the stock at around £3, then again at about £6, and then at roughly £9.
On each occasion, many in the markets were saying the price had run its course, ignoring the remaining value. So I will go my own way again and snap the stock up once more at the earliest opportunity.
I also have my eye on other stocks with similar strong underlying growth momentum to Rolls-Royce, which also look underpriced.
