Can Rolls-Royce shares continue to outperform in 2025?

At the start of the year, I wrote that I thought Rolls-Royce (LSE:RR) shares were undervalued heading into 2024. That was despite the stock having roughly tripled in 2023.

Since then, it has climbed another 90%. And while I’m still positive on the stock going forward, I’m more cautious heading into 2025.

Earnings growth

Rolls-Royce is still firmly on a growth trajectory. Earnings per share are expected to go from 14p in 2023 to 18p this year – and it’s not just about a Covid-19 recovery any longer.

There are also plenty of reasons for future optimism. An expansion into narrow-body aircraft, a shift to sustainable aviation fuels, and a rise in nuclear energy are potential opportunities.

Analysts are forecasting earnings per share to reach 21p in 2025 and 29p by 2027. I think this could well turn out to be accurate.

Rolls-Royce EPS forecasts

Source: TradingView

Despite this, some of the reasons I had for being positive on Rolls-Royce shares at the start of 2024 are gone. So it’s worth reconsidering the stock from an investment perspective.

Valuation

The biggest reason is valuation. One of the reasons I gave at the start of the year was that Rolls-Royce shares were trading at a discount to their counterparts elsewhere in Europe.

The FTSE 100 stock was trading at a price-to-earnings (P/E) ratio of 15. But that was lower than the firm’s European counterparts, which were trading at P/E multiples above 20.

In fact, that’s where a lot of the increase in the Rolls-Royce share price has come from. The stock is up 90% but earnings per share are only set to increase 28%.

As a result, the valuation gap I was seeing at the start of the year has closed. So while it’s possible the P/E multiple could expand further in 2025, I’m not expecting it to.

Growth

The other reason I’m hesitant on Rolls-Royce shares in 2025 is growth. Over the next few years, earnings per share growth is expected to go from 18% to 16% to 14%.

To some extent, this should come as no surprise to investors as the company recovers from an unusually difficult period. But I’m not expecting 16% earnings growth to push the stock up 90%.

There are also some short-term issues. Problems at both Boeing and Airbus have led to aircraft being grounded – and the effect of reduced flying hours on Rolls-Royce is well known.

That makes me cautious about the anticipated 16% earnings growth for 2025. I’m not ruling it out, but the firm wouldn’t be the only aerospace engineer to find the environment challenging.

Outperformance?

I think there are strong reasons not to expect the Rolls-Royce share price to repeat its performance over the last couple of years. But I think it could still outperform the FTSE 100.

The valuation gap to its European peers has closed up, but it isn’t extravagant. And while 16% earnings growth isn’t spectacular, it’s still pretty strong.

Rolls-Royce shares might not be the bargain they once were. But I think investors could well see the stock do well in 2025 and beyond. I believe the stock is worth considering.

The post Can Rolls-Royce shares continue to outperform in 2025? appeared first on The Motley Fool UK.

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Stephen Wright has no position in any of the shares mentioned. The Motley Fool UK has recommended Rolls-Royce Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.