Rolls-Royce (LSE:RR) shares have surged 32% over the past two weeks. That’s truly phenomenal and it means the shares are now up 808% over three years. It’s an incredible turnaround and it shows us that multibaggers — stocks that at least double in value — well and truly exist on the FTSE 100. So, this means that £10,000 invested in Rolls-Royce shares two weeks ago would now be worth £13,200.
What’s behind the surge?
Rolls-Royce shares have leapt over the past two weeks due to a combination of strong financial performance, strategic announcements, and broader market trends. On February 27, the company reported a 55% increase in underlying operating profit to £2.5bn for 2024, driven by growth in its civil aerospace, defence, and power systems divisions. The firm also reinstated dividends at 6p per share and announced a £1bn share buyback, marking its first dividend since the pandemic.
The company upgraded its mid-term guidance, targeting underlying operating profit of £3.6bn-£3.9bn and free cash flow of £4.2bn-£4.5bn by 2028, which boosted investor confidence. CEO Tufan Erginbilgic emphasised the transformation of Rolls-Royce into a high-performing, competitive business, with significant improvements in margins and cash flow.
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Additionally, the defence sector rallied in early March, with JPMorgan raising its target price for Rolls-Royce to 900p, citing a European “rearmament cycle” and increased defence spending. This sentiment was further bolstered by announcements from Denmark, the UK and Germany regarding significant boosts to their defence budgets, which are expected to benefit Rolls-Royce’s defence division.
Overall, Rolls-Royce’s strong financial results, shareholder rewards, and favourable market conditions in the defence sector have driven its stock price to record highs. It’s a far cry from the situation the stock found itself in during Liz Truss’s premiership — it wasn’t her fault — with the shares changing hands for around 60p each.
A valuation conundrum
Rolls-Royce’s forward price-to-earnings (P/E) ratio of 31.5 times suggests the stock may appear expensive compared to the broader market, particularly as it exceeds the FTSE 100 average. However, Rolls-Royce operates in a niche aerospace and defence sector with few direct peers, which limits meaningful comparisons. General Electric (NYSE:GE), a key competitor, trades at a higher forward P/E of 33.3 times, indicating that Rolls-Royce’s valuation isn’t an outlier in its industry.
The elevated P/E ratio reflects investor confidence in Rolls-Royce’s growth trajectory, driven by its strong recovery post-pandemic, upgraded mid-term guidance, and strategic initiatives like dividend reinstatement and share buybacks. Analysts project robust earnings growth, with a compound annual growth rate (CAGR) of 28.1% over the next three to five years, supported by rising defence spending and operational improvements.
As with every time the Rolls-Royce share price jumps, I’m holding my position until I’ve thoroughly reassessed the value proposition and judged market sentiment. What’s more, with my investment up six times, it’s already a sizeable part of my portfolio. As such, adding more may introduce some concentration risk.
Moreover, despite the fact that business is currently booming, we know that Rolls-Royce is quite reliant on earnings from the civil aviation segment. The pandemic highlighted this very acutely, with some suggesting the business could actually go under. Another grey swan event like the pandemic would be unfortunate but investors should always be wary.
