Rolls-Royce (LSE: RR) has experienced a remarkable increase in its share price, yet investors may not fully grasp the underlying factors that could propel it even higher. Three significant elements stand out, suggesting a substantial growth potential for the aerospace and defence giant.
Still Undervalued Compared to Peers
Currently, Rolls-Royce trades at a price-to-earnings (P/E) ratio of 14.9, significantly lower than the average of its competitors, which exceeds 30.1. For instance, Northrop Grumman has a P/E ratio of 20.1, BAE Systems stands at 24.9, RTX is at 35.2, and TransDigm reaches 40.3. This disparity illustrates that Rolls-Royce shares remain undervalued relative to the earnings generated by comparable companies. The current P/E ratio reflects past earnings, but when considering the forward P/E ratio, which incorporates analysts’ forecasts for the next twelve months, Rolls-Royce still appears undervalued at 22.5, compared to a peer average of 28.3.
Robust Growth Across Core Businesses
Rolls-Royce is experiencing exceptional growth within its three primary sectors. In Civil Aerospace, large-engine flying hours have surpassed pre-COVID levels, substantially boosting service revenues. The demand for the Trent XWB-97 engine remains strong, with upgrades extending both flying time and profitability. Margins in Civil Aerospace reached an impressive 24.9% in the first half of 2025.
Power Systems also reported strong order intake and revenue growth, primarily driven by increasing demand from data centres and government projects. In October, the company launched a fast-start gas generator, which is set to be available from 2026.
In the Defence sector, demand is robust, particularly due to the Global Combat Air Programme, a collaborative stealth fighter project involving the UK, Italy, and Japan, expected to be operational around 2035. Recent months saw expanded submarine partnerships and an agreement between Turkey and the UK for 20 Eurofighter Typhoons powered by Rolls-Royce’s EJ200 engines. The company is also making strides with its Small Modular Reactor nuclear business in Sweden and the UK, along with involvement in the United States’ Project Pele, aimed at developing a mobile nuclear microreactor for remote military bases.
While the growth potential is evident, risks remain. Any significant product failures could lead to costly remedies and potential damage to the company’s reputation.
Underestimated Growth Potential
Since Tufan Erginbilgic took over as CEO in 2023, there is a growing belief among investors that the potential for growth is underestimated. The guidance for underlying operating profit in 2025 has been upgraded from £2.7 billion-£2.9 billion to £3.1 billion-£3.2 billion. The reported figure for the first half of 2025 stood at £1.733 billion, indicating a projected full-year total of £3.466 billion, which already exceeds the revised forecasts.
Furthermore, the free cash flow forecast for 2025 was increased from £2.7 billion-£2.9 billion to £3 billion-£3.1 billion. The first half cash flow amounted to £1.582 billion, suggesting a full-year figure of £3.164 billion. Erginbilgic noted, “We see these targets as a milestone, not a destination.”
As the market appears to base its expectations for Rolls-Royce on conservative figures, there may be a significant valuation gap in the stock. This presents an opportunity for investors.
In conclusion, the combination of Rolls-Royce’s undervalued status, robust growth across its core sectors, and the potential for continued expansion suggests that the company is positioned for further success. Investors may want to consider reinforcing their holdings in this promising firm.
