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The Rolls‑Royce (LSE: RR) share price has surged a phenomenal 122 % in the last year and become the darling of the FTSE 100.
With shares in the aerospace and defence group continuing to climb, it made me wonder: have investors like me simply missed the boat?
Recent performance
There’s no doubt that the company’s shares have been on a tear in recent years. Its valuation has rocketed an impressive 123% higher to £10.70 as I write on 4 September.
Aviation demand is rebounding, defence budgets are lifting, and the group continues to win crucial long-term contracts.
Following the rally in recent years, the company now has a price‑to‑earnings (P/E) ratio of 15.7 which is a touch above the Footsie average of around 13.
Having recently restarted dividend payments, the stock has a modest 0.7% dividend yield and remains one of the largest stocks in the UK large-cap index with a £90bn market cap.
Valuation
Let’s compare it with industry peer BAE Systems, which commands a much more lofty P/E of 27 and offers a dividend yield of 1.9 %. At face value that makes Rolls‑Royce’s valuation look cheap relative to its aerospace/defence rival.
That to me says there’s potential for the company’s share price to climb further in 2025 and beyond. BAE’s premium also reflects its long-term-quality, strong backlog and diversified programmes across air, maritime and more.
I think the fact that the company’s P/E ratio is broadly in line with the Footsie average is somewhat surprising. After all, this is a stock that has surged over 1,300% in the last five years.
Growth drivers
Back with Rolls-Royce, a 120%+ gain in 12 months is no small feat. It has clearly benefitted from its leading position in the revival of commercial aviation and higher defence spending.
Management continues to right the ship and that has been an enormous contributor to the current valuation. Free cash flow has continued to grow and earnings guidance remains strong for the year ahead.
I think the current valuation is quite delicately poised with the P/E ratio of 15.7 being reasonable and reflecting its growth profile. For a strong global business that has improving fundamentals, that premium to the Footsie could be justified.
The company has a healthy order book and strong operational momentum. However, it’s not all sunshine, as with any investment, and particularly a hot stock like Rolls-Royce.
My verdict
Investors will be expecting a lot given its recent run and current price. The business must keep delivering and any threats to growth or margins could see the share price come under pressure.
There’s also cyclicality to the company’s business, and it does carry a some debt on its balance sheet, which introduces financial risk.
My verdict? I think the company’s share price could still have further to run, even though it’s delicately balanced at the moment.
But with solid fundamentals, a compelling potential growth story and reasonable relative value I think it’s certainly one for investors to consider for the long term.
This story originally appeared on Motley Fool
