Trading Strategies: rating Rolls-Royce’s share price potential

Two Rolls-Royce Trent 1000 TEN engines. Credit: Flickr.

The FTSE 100 index has delivered a 0% capital return in the past six months. Having reached an all-time high at the end of February, the index slumped by 9% during March in response to the war in Iran. Although it has subsequently made gains, the UK’s large-cap index still trades marginally below its record level.

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Clearly, some investors may question whether sufficient catalysts are present to push it to a materially higher level over the coming months. Indeed, the internationally focused FTSE 100’s performance could be negatively affected in the short run by several major economic and geopolitical challenges that are presently showing little sign of abating.

Short-term uncertainty

In the past month, for instance, inflation readings in developed economies such as the US, UK and the eurozone have remained well in excess of central bank targets. When combined with the fact that inflation in all three regions has proved far stickier and long-lasting over recent years than previously anticipated, this suggests that interest rate rises are more likely to be implemented than rate cuts over the near term.

Alongside a lack of monetary policy stimulus in the short run, the outlook for the world economy and the FTSE 100 stocks that rely on it is set to be weighed down by ongoing geopolitical threats. The war in Iran, for example, remains ongoing and could quickly scale without warning. Furthermore, the present era of elevated protectionism is showing little sign of ending. This could further weigh on GDP growth rates and, ultimately, on company profits, investor sentiment and index performance.

A strong track record

In the long run, though, the FTSE 100 is extremely likely to not only surpass its all-time high, but to make further subsequent record highs. After all, the index has a long track record of doing so, with it having always ultimately recovered from setbacks, corrections and bear markets to reach previously unchartered territory.

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Since its inception in January 1984, moreover, it has produced an annualised total return above 8%. This figure not only provides guidance on what investors can reasonably expect the index to deliver over an extended time frame; it also highlights both the appeal of the index versus other mainstream asset classes and suggests that investors who stick with it for the long term are likely to ultimately be generously rewarded.

Long-term growth outlook

In terms of potential catalysts, inflation is expected to fall in the US, UK and the eurozone over the medium term. In fact, it is set to be just 20 basis points higher than the Bank of England’s 2% target by the end of next year, with inflation in both the US and eurozone forecast to equal Federal Reserve and European Central Bank (ECB) targets by the end of 2028.

This should provide scope for central banks to resume, or return to in the case of the ECB, monetary policy easing. Once time lags have passed, this is likely to stimulate both the rate of GDP growth, as well as corporate profitability and investor sentiment towards cyclical firms in particular. Over time, this could lead to a material rise in the FTSE 100 index’s price level.

Elevated volatility

Of course, making an accurate assessment of the outlook for previously mentioned geopolitical risks is not possible given their inherent unpredictability. However, investors in FTSE 100 stocks may be able to mitigate them to some extent by focusing on stocks that offer fair value for money based on their financial standing, competitive positions and long-term growth prospects.

Clearly, their share prices, and therefore the performance of the wider index, could prove to be relatively volatile at times in future. However, such stocks are also likely to produce attractive returns in the long run based on their past performance and an increasingly favourable outlook for inflation, interest rates, as well as GDP growth, across several major developed economies.

Upbeat financial forecasts

Source: ShareScope, 27 August 2026. Past performance is not a guide to future performance.

FTSE 100 aerospace and defence company Rolls-Royce Holdings (LSE:RR.) appears to offer a favourable risk/reward ratio on a long-term view. Its recently released half-year results showed it continued to perform well during the six-month period despite the presence of elevated geopolitical risks, notably conflict in the Middle East, which negatively affected parts of the wider civil aerospace industry.

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In fact, its earnings per share (EPS) rose by 41% year on year, with the company raising financial guidance for the full year. It’s now expected to deliver a 29% annualised rise in profits on a per share basis over the next two financial years. That’s because it will benefit from the effects of an ongoing £2.5 billion share buyback programme that is due to complete this year and which forms part of a £7 billion-9 billion repurchase programme over the three years to 2028. Given that the company has a net cash position of £2.1 billion, this seems to be a logical use of excess cash.

Segmental outlook

Rolls-Royce’s EPS is also set to be catalysed by an upbeat long-term outlook for its defence segment. A rise in the proportion of GDP spent annually on defence by NATO members, which includes some of the world’s largest economies, from 2% to 5% by 2035, is likely to prompt rising demand for the firm’s products. And with military spending being expressed as a proportion of GDP, a prospective fall in inflation and potential interest rate cuts across the US, UK and the eurozone are likely to further boost the segment’s performance.

Similarly, the company is becoming increasingly well placed to benefit from the world’s focus on achieving net zero. Indeed, demand for the firm’s battery energy storage systems and small modular reactors, for example, is likely to rise as major economies continue to seek to decarbonise.

Near-term threats

Clearly, the near-term prospects for the firm’s civil aerospace segment are relatively uncertain given the situation in the Middle East. Indeed, the continuation of conflict in Iran could mean that elevated jet fuel prices persist and lead to reduced passenger demand. It may also prompt further flight disruption that weighs on demand for aircraft engines and aftermarket services.

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On a long-term view, though, the outlook for Rolls-Royce’s civil aerospace segment remains upbeat. Falling inflation and prospective interest rate cuts across major developed economies are likely to provide consumers with greater spending power that leads to higher demand for discretionary items such as travel. And with global passenger numbers widely expected to materially rise over the long run, while efficiency remains a key focus for airlines, demand for new aircraft engines and their subsequent maintenance is likely to remain robust.

Risk/reward ratio

While the FTSE 100 index is flat over the past six months, Rolls-Royce’s share price has risen by 14% over the same period. In fact, it has gained 34% this year and is up 1,220% in the past five years. As a result, it currently trades on a forward price/earnings (PE) ratio of 35.8, which is materially higher than the UK large-cap index’s earnings multiple of around 16.

While this indicates that upward rerating potential is highly limited, Rolls-Royce’s strong growth prospects and solid fundamentals mean it still offers good value for money. Although its shares are likely to experience elevated volatility at times given the presence of ongoing economic and geopolitical risks, further capital gains could also be ahead over the long run.

Robert Stephens is a freelance contributor and not a direct employee of interactive investor.