Image source: Rolls-Royce plc
The stock with the best performance of the group FTSE 100 Last year's index was aeronautical engineer. Rolls-Royce (LSE: RR). Fast forward to 2025, has that huge growth in Rolls-Royce share value been reversed?
As if.
In fact, Rolls-Royce's share price has soared so far this year, it's up to 93%. Compared to 5% for the FTSE 100 as a whole, this is an exceptional performance once again.
What is driving the share price rise?
To analyze the reasons behind this price increase, I think it is useful to consider a few different factors.
One is customer demand. After a very difficult time due to government-imposed travel restrictions and weak consumer demand during the pandemic years, airlines have been struggling to meet growing demand, meaning they have been serving planes and ordering new ones.
Manufacturing aircraft engines is a difficult and expensive business, so there are high barriers to entry. That gives the few dominant players, like Rolls-Royce, pricing power.
Another factor has been performance beyond the main civil aviation division. European governments have increased military budgets, helping Rolls' defense division. Meanwhile, its expertise in nuclear power generation is increasingly in demand.
But there have also been internal factors at play. Since early last year, new management has set very aggressive growth targets. So far, business performance has been strong. I think that if Rolls-Royce continues to look to meet or even exceed those targets, its share price could rise even further from here.
The current price-to-earnings (P/E) ratio of 21 may seem high today (at least to my taste). However, if earnings grow strongly (as the company's strategy suggests), the forward P/E ratio looks to me like it could actually still be potentially cheap from a long-term investor's perspective.
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Potential for higher earnings, but no guarantees
What is putting me off investing in Rolls-Royce (and I have no plans to buy shares at this time) is what else could happen.
For example, what happens if the ambitious growth plan fails?
Rolls has a history dating back decades of mixed performance. Look, for example, at its skyrocketing earnings per share.
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Its business involves large fixed costs and projects with schedules that can change dramatically due to external factors, such as aircraft manufacturers pushing back launch dates.
I think Rolls-Royce's current share price reflects investors' hopes that the company will deliver on its plans. So if that doesn't happen, I expect the stock price to fall.
Another significant but external factor that, once again, Rolls has struggled with for decades is civil aviation demand shocks beyond its control. The pandemic was just the latest in a long line of such shocks, from the 2001 US terrorist attacks to the clouds of volcanic dust that grounded European aviation.
I see the risk of some such event again strangling demand at some unknown future point.
As far as I'm concerned, Rolls-Royce's current share price does not offer me enough margin of safety to offset such risks.
