Could already-expensive Rolls-Royce shares reach £20?

If you follow Rolls-Royce (LSE:RR) shares closely, you’ll know they’re pretty expensive. I don’t mean they’re expensive because they’re £12.50 each rather than the 70p they were three years ago. I mean they’re expensive on conventional valuation metrics.

Valuation metrics are the most important method of understanding whether a stock is a good investment or not. I don’t think it should be based on some notion or principle like “I think migration will drive housing prices up and therefore house builders are a good shout”.

One of the core metrics is the price-to-earnings (P/E) ratio. And this is one that is easily applied to an industrials stock like Rolls-Royce. The stock trades at 38.9 times forward earnings, a huge premium to the sector average, which is around 22.5 times.

Of course, this is just a starting point. Let’s explore.

Already so expensive

A high P/E ratio — the forward ratio is always more telling than the trailling figure — tells us a bit about the valuation, but not everything. It needs to be combined with forecasts on earnings growth, dividends, profitability, and the balance sheet.

Firstly, Rolls has a perfect balance sheet. The company’s net cash position is around £1.1bn, which is great. It’s not a huge figure given this is a £106bn-company, but it’s far better than a net debt position.

Then there’s profitability. Operating margins have been improving and currently sit around 20.6%. That’s above the industry average and a testament to the company’s pricing power.

And then there’s growth. Analysts forecast that earnings will grow around 18.7% per year on average over the medium term. We can combine that figure with the forward P/E to reach a price-to-earnings-to-growth (PEG) of 2.1.

Now, the PEG ratio — a favourite of mine — is a growth-adjusted valuation. Traditionally, a ratio below one was a signifier of good value. At 2.1, Rolls looks overvalued, but it does have a great balance sheet and it’s clearly a quality company — strong margins and moats.

The dividend yield sits below 1% and probably isn’t worth thinking about.

In short, this suggests that Rolls shares won’t go much higher because they’re already expensive.

The wildcard

One potential wildcard for Rolls-Royce shares is its small modular reactor (SMR) programme.

The division currently generates no material revenue, meaning it contributes little to the group’s roughly Â£20bn annual sales base, which is now firmly underpinned by a fully recovered civil aerospace business, alongside defence and power systems.

As a result, SMRs remain largely excluded from near-term earnings models and valuation frameworks.

That said, forecasts point to meaningful long-term potential. Rolls-Royce estimates global demand for hundreds of SMRs by mid-century, while external analysts suggest the nuclear business could ultimately be worth around £10bn.

In theory, this could happen in the next 10-15 years. Coupled with steady growth in existing verticals, total revenue could feasibly reach £40bn-45bn per year.

Because expectations are low today, any tangible progress on approvals, funding, or contracts could re-rate the stock disproportionately,.

So, in theory, and applying a consistent price-to-sales ratio, there absolutely is scope for the stock to trade near or above £20 per share. However, there are so many moving parts here and SMRs will undoubtedly be priced in to some extent already.

Personally, I think the stock is worth considering, but better value can be found elsewhere.

The post Could already-expensive Rolls-Royce shares reach £20? appeared first on The Motley Fool UK.

More reading

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• After rising 113%, is Rolls-Royce’s share price on course for £16.25?
• At new record highs, is there still value in Rolls-Royce shares?
• Next stop £15, after Rolls-Royce shares soar 10% so far in 2026?
• 3 no-brainer UK stocks to consider buying now with just £100?

James Fox has positions in Rolls-Royce Plc. 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.

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