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Rolls-Royce (LSE:RR) shares are the Crown Jewels of the FTSE 100. The stock’s climbed more than 1,000% from lows over two years ago.
However, there are compelling reasons to believe its shares could still push higher, despite a valuation that looks stretched compared to both its sector and historical averages.
The premium valuation
On a forward price-to-earnings (P/E) basis, Rolls-Royce trades at 37.3 times for 2025, above the sector median of 20.4 times. Other valuation metrics, such as enterprise value-to-EBITDA and price-to-sales, also sit at significant premiums to sector norms.
At first glance, this might suggest the shares are vulnerable to a pullback, particularly if earnings growth disappoints or the macroeconomic environment deteriorates.
However, the market appears willing to pay up for Rolls-Royce’s unique position in the global aerospace and power systems markets. The group’s economic moat is underpinned by its dominant position in the civil aviation engine market. It’s one of only a handful of suppliers to the world’s largest aircraft manufacturers.
Its engines power many of the jets that form the backbone of global aviation, and its installed base generates lucrative, recurring revenue from long-term service agreements. This so-called ’razor and blade’ model — selling engines at low margins but locking in high-margin maintenance contracts — provides revenue visibility and pricing power that few industrial peers can match.
Cheaper than GE
Compared to GE Aerospace, one of its closest peers, Rolls-Royce actually looks a little cheaper. For 2025, GE’s is even higher at 44.3 times. GE’s price-to-sales and price-to-book ratios are also notably richer.
Both companies enjoy wide economic moats and resilient aftermarket revenues. However, Rolls-Royce is forecast to deliver faster earnings growth next year — 36.9% versus GE’s 21%.
While GE’s premium reflects its size and diversification, Rolls-Royce’s sharper growth and successful turnaround suggest its shares could still have room to close the valuation gap with its American rival.
The bottom line
Rolls-Royce is benefitting from a powerful cyclical upswing in global air travel and aircraft deliveries. Airlines are ramping up capacity after years of underinvestment, and demand for new, fuel-efficient jets is strong. As such, Rolls-Royce’s order book is swelling, and the company is guiding for strong double-digit earnings growth through 2026.
Despite CEO Tufan Erginbilgiç‘s aggressive cost-cutting portfolio rationalisation, and a renewed focus on cash generation, risks remain. The pandemic highlighted that Rolls-Royce is reliant on flying-hours contracts and that future disruptions in civil aviation could really hurt the business.
However, while the shares aren’t cheap by conventional measures, Rolls-Royce’s economic moat, improving fundamentals, and exposure to long-term growth trends in aviation and energy transition could support further appreciation.
Despite this, I’m not adding to my Rolls-Royce holdings. Concentration risk’s one issue. But also I believe there’s a cheaper peer in the market with great credentials.
That’s Melrose Industries. While Rolls has a price-to-earnings-to-growth (PEG) ratio around 2.7, Melrose is around 0.7.
