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Five years ago, Rolls-Royce (LSE:RR) demolished all others FTSE 100 shares. And it’s not even close, with its 1,200% return more than double that of the runner-up Babcock International (+525%).
Yet despite this impressive performance, no investment is perfect. And it’s important to look at the stock casually.
With this in mind, let’s take a look at Rolls-Royce in terms of the good, the bad, and the unknown.
Things seem to be going well
The positives clearly center around the company’s impressive financial performance. In a November market update, management confirmed the engine maker was on track to deliver full-year underlying profit of £3.1bn-£3.2bn and free cash flow of £3bn-£3.1bn.
Worse, this was happening despite ongoing supply chain challenges across the aerospace sector.
I look forward, UBS it thinks free cash flow could reach £5.6bn by 2028, slightly higher than market expectations. The bank estimates both the Civil Aerospace and Power Systems segments will see the highest margins during that period.
As a result, UBS analysts have a price target of 1,625p on the shares, which is 34% above the current level. Many other analysts are still working on the stock as well.
So the good news here is that Rolls-Royce is doing well despite the supply chain challenges, and is set to become very profitable in the next few years.
On the other hand, the company’s small modular reactor (SMR) business has great potential for growth. According to the International Energy Agency, there could be as many as 1,000 SMRs worldwide in 24 years.
Finally, the company’s balance sheet is in excellent shape, supporting dividends and continued share buybacks.
The price of perfection
The downside of investing here is that the stock is overpriced. That said, much of the future growth from higher aircraft engine hours and increased defense spending appears to be already baked in.
That’s because the average forward earnings are 37. While this doesn’t stop the share price from going higher, it leaves a small margin for error. Even disappointing guidance for 2026 in the company’s next update in late February could trigger a major selloff.
As mentioned, there are also the challenges of bubbling in the background. Aircraft manufacturer Airbus has flagged continued supply pressures across the industry through 2026.
And another unknown…
Another unknown is when the company will commit to re-entering the short-haul market. According to Airbus’ latest global forecast, 34,250 new single-aisle aircraft will be needed between 2025 and 2044 to meet peak travel demand.
Obviously, this is another huge potential growth opportunity. Rolls-Royce has said it intends to re-enter this market through partnerships, but we do not know the details of this yet. How much will it cost?
Another unknown is how long CEO Tufan Erginbilgiç will hold on. The board recently offered him a big pay raise, and there’s no suggestion he’s considering leaving. But Erginbilgiç quitting or leaving would be a big blow. Who could fill his shoes?
In summary, there are several different factors that investors should consider regarding Rolls-Royce shares. In the long term, the company’s growth prospects still look very strong, but the stock may be overpriced for now.
We’ll find out more when the engine maker reports 2025 earnings on February 26.
