The FTSE 100 has been going sideways for years. While there’s certainly an argument that British stocks are undervalued, many of them offer very little in the way of growth.
Rolls-Royce (LSE:RR) is a different proposition. It has gone from fears that it would never recover during the pandemic to a company that just keeps on beating earnings estimates. But why do I think it could still be the best value FTSE 100 stock? Let’s take a look.
Valuations
Rolls-Royce isn’t ‘expensive’ even after surging around 500% from its lows 18 months ago. The stock is currently trading at 28.1 times forward earnings. That’s notably cheaper than a couple of months ago and it’s because analysts’ estimates for the company’s earnings just keeps on getting stronger.
| 2024 | 2025 | 2026 | |
| Earnings per share (p) | 14.22 | 17.35 | 20.4 |
To add some context, earnings estimates for this year have surged. One year ago, analysts thought Rolls-Royce would earn around 6p a share in 2024. But the estimate — yes, it’s still an estimate — has more than doubled during the period.
Forecasts have grown stronger because Rolls-Royce has just kept on beating forecasts. Looking forward, Rolls is trading at 22.9 times earnings for 2025, and 19.6 times earnings for 2026. These earnings are attractive when we compared to peers, including General Electric.
| 2024 | 2025 | 2026 | 2027 | |
| Price-to-earnings | 36.5 | 28.31 | 23.37 | 20.94 |
While General Electric’s earnings are growing across the medium term, the stock still looks more expensive than Rolls at all given points.
Flying with tailwinds
First of all, we need to highlight that Rolls-Royce has a significant economic moat. In fact, I believe it has one of the best moats on the FTSE 100. The engineering giant operates in three industries that have extremely high barriers to entry: defence, civil aerospace, and power systems.
Predictably, the civil aviation and defence sectors are booming given the broader economic and geopolitical environment. However, the power systems sector is performing well too. Operating profit was £413m for the last year, a 44% year-on-year increase.
Perhaps the strongest tailwinds are coming from civil aerospace. The sector is expected to require more than 80,000 new engines over the next two decades. This is huge, but there’s a risk that Rolls’s 2011 tilt to the wide-body market may mean it misses out on 80% of expected orders.
Finding fair value
Rolls-Royce has a price-to-earnings-to-growth ratio of 0.67, and that suggests that it could be significantly undervalued. As fair value is demonstrated by a ratio of one, we could deduce that Rolls is undervalued by as much as a third. And this is broadly reinforced by discounted cash flow calculations, which highlight the stock could trade as much as 38% higher. That’s why I think it could be the best value stock on the FTSE 100.
