A PUBLICATION FROM REDMAYNE BENTLEY
MODERATING EXPECTATIONS
IN THIS ISSUE
PRICING PERFECTION: INVESTING AT HIGH MULTIPLES ROLLS-ROYCE
Pricing Perfection: Investing at High Multiples
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Investments and income arising from them can fall as well as rise in value. Past performance and forecasts are not reliable indicators of future results and performance. There is an extra risk of losing money when shares are bought in some smaller companies. Redmayne Bentley has taken steps to ensure the accuracy of the information provided.
Please note that this communication is for information only and does not constitute a recommendation to buy or sell the shares of the investments mentioned.
MODERATING EXPECTATIONS
ALASTAIR POWER INVESTMENT RESEARCH MANAGER
As we progress through the latter months of 2025, investors can look back on a year which has thus far provided strong returns. UK equities, represented by the FTSE All Share index, have outperformed European, US, and world equity indices in local currency terms at the time of writing, gaining 17.5% this year so far, with particularly strong performance from the financial and defence sectors. Within bond markets, positive returns have been generated across high grade UK corporate and government indices, with shorter dated gilts providing greater returns than longer dated peers.
Optimism around the macroeconomic environment remains subdued. August’s figures showed elevated inflation rates with a 3.8% year-over-year increase in prices, well above the Bank of England’s target rate of 2%. Despite slowing from 5.0% to 4.7%, the annual rate of services price increases remains a challenge for the Bank of England, which could prevent any further declines in interest rates in 2025 having seen three rate cuts earlier in the year.
Despite headwinds of stubborn inflation and a cooling labour market, the UK economy continues to grow, albeit at a slowing rate. October GDP estimates released by the Office for National Statistics indicate real GDP growth of 0.3% in the three months to August 2025, and 1.3% growth over the 12-month period. A recent World Economic Outlook from the International Monetary Fund added positive rhetoric with the expectation of our economy experiencing the third fastest growth of G7 nations in 2026 at 1.3%. This figure is, however, 0.4 percentage points lower than forecasted in October 2024.
Political developments add another layer of uncertainty to the economic outlook. Chancellor Rachel Reeves’ upcoming Autumn Budget on 26th November is a key event for investors. Speculation around sector-specific tax hikes could reshape market sentiment, but the ongoing commitment to her fiscal rules appears to be well received by bond markets with the 10-year gilt yield declining nearly 20 basis points since the start of October. Several high-profile institutions have urged for a larger buffer to stabilise the country’s fiscal position which, if achieved, could result in positive performance within the gilt market. The main challenge is preventing continued speculation of further tightening at each subsequent fiscal forecast.
Outside the UK, challenges continue to be experienced by other developed nations, from a US government shutdown to the inability of France to form a government. Global technology companies, especially those associated with Artificial Intelligence (AI), appear immune to these issues as they continue to see strong share price appreciation. Global AI spending is expected to total nearly US$1.5tn in 2025 and rise to US$2tn in 2026, according to US based business and technology insights company, Gartner, resulting in increased speculation around the potential for an asset price bubble. Companies associated with the industry, and thus the S&P 500 index given their high constituent weight, continue to trade at high valuations, posing questions around how to invest in a highly valued market, which forms the topic of our main article.
Looking forwards, an environment of moderating inflation and declining interest rates can be considered supportive to continued positive performance of financial markets. Sentiment to key events such as the US government shutdown and the upcoming Autumn Budget pose risks, along with lofty valuations found in select areas, especially in the short-term.
Please note that this communication is for information only and does not constitute a recommendation to buy or sell the shares of the investments mentioned. Investments and income arising from them can fall as well as rise in value. Past performance and forecasts are not reliable indicators of future results and performance. The information and views were correct at time of publishing but may have changed at point of reading.
ROLLS-ROYCE
RUTH HARRIS | INVESTMENT RESEARCH ANALYST
Rolls-Royce plc is an aerospace and defence company that listed in 1987, the motor company having been separated out years before. Prior to its recent meteoric share price rally, up over 1500% in the last 3 years, it was regarded as a highly out of favour and risky company by investors. It is an example of how value investing, looking for companies that are optically cheap and unloved by the market, can work if the right catalysts for change emerge. Today despite its much stronger share price, it remains an attractive name to many investors due to the positive growth outlook and much improved operational efficiency.
The company operates across three divisions. Civil Aerospace covers commercial jet engines and aftermarket services, while Defence involves engines for the military, navy, and submarine nuclear propulsion. The Power Systems division makes highspeed engines and power generation systems used in marine, energy, industrial, and government sectors. Rolls-Royce’s business model typically involves installing engines at a loss, then making profits on aftermarket services over subsequent years. Contracts are ‘power by the hour’ where Rolls-Royce is paid per mile flown by the aircraft, in exchange for providing long term maintenance, repair, and overhaul.
The 2010s were a turbulent decade for the company, with then-CEO Warren East facing compounding challenges which ultimately threatened the future of the business. The company was saddled with a bribery settlement for long-running corrupt practices, with a substantial impact on reputation along with £671m in payments to regulators across the UK, US, and Brazil. There were also persistent problems with the durability of its Trent 1000 engine family, with flights grounded due to technical problems. This pushed up the costs for Rolls-Royce as it honoured its lifetime maintenance support contracts, as engines needed inspecting and repairing more frequently than anticipated. The operational difficulties culminated in a £790m exceptional charge in 2018 to cover the cost of fixing the Trent 1000 issues. It also frustrated clients, damaging business relationships and leading to compensation claims as well as the loss of several key contracts. The balance sheet became progressively more unstable, and the company struggled with cashflow given the structure of its contracts. While the CEO was working to stabilise the outlook, credit ratings companies downgraded Rolls-Royce’s debt in 2019 due to cashflow concerns.
The forward price to earnings ratio is 38.7x, well above the FTSE 100 average of 14.1x.
The Covid-19 pandemic could have threatened the future of Rolls-Royce, given its weak position and ‘power by the hour’ contracts linking revenue to airtime, with many planes grounded. The share price fell below 40p in mid-2020, with a great deal of uncertainty around the outlook for the company. Such investment opportunities can appeal to ‘deep-value’ investors, who look for shares trading at a sharp discount, where the risk-reward payoff is more attractive than perceived by other financial market participants. However, such a strategy involves significant risks, with ‘value-traps’ being companies that are cheap because they are poor investments. Some investors look for a catalyst for change, either external or internal, as an indicator that a company’s fortunes could improve. For Rolls-Royce, this began with multiple rounds of layoffs and cost cutting measures, along with a rights issue and debt raise in 2020 to inject more cash into the business and strengthen the balance sheet. This was supported by the UK Government, which has a substantial stake in the business due to the strategic importance of military aircraft engines. The company was able to weather the pandemic, and in 2023 the board brought in a new CEO, Tufan Erginbilgic, to turn the business around. Commercial discipline rapidly improved, with better contract writing and a focus on cashflow management, along with further job cuts and the disposal of
less profitable areas of the business. Revenues and margins improved quickly, with further tailwinds from a post-Covid increase in flying and rising geopolitical tensions leading to government pledges to increase defence spending.
The company no longer looks like the value stock it was five years ago, with a share price of over £11, up from its lows of under 40p. The forward price to earnings ratio is 38.7x, well above the FTSE 100 average of 14.1x. This reflects high expectation for future earnings, and continued improvements in execution. Much of the business is still cyclically exposed too, given the reliance on flight hours in consumer air travel. Any weakening in the global economy could hurt this area, while defence-related contracts are more resilient.
Though there are considerable downside risks in the share price, and it may no longer appeal to a value-style investor, those taking a long-term positive view on the quality of the business may still find appeal in Rolls-Royce. Recent results have been exceptionally strong, with underlying operating profit for the first half of 2025 up 50% compared to the same period in 2024. The company has a sound strategic vision including efficiency gains and further investment, as well as reporting new major defence contract wins which is likely to be a key theme moving through the latter half of the decade. It has also bought back shares, with a total £1bn worth expected to be repurchased, implying that they are not seen by the company as overvalued at the current level. Investors may continue to find Rolls-Royce an attractive opportunity for the long-term, on the strength of the recent track record and growing end markets.
Please note that this communication is for information only and does not constitute a recommendation to buy or sell the shares of the investments mentioned. Investments and income arising from them can fall as well as rise in value. Past performance and forecasts are not reliable indicators of future results and performance. The information and views were correct at time of publishing but may have changed at point of reading.
TOPIC OF THE MONTH
PRICING PERFECTION: INVESTING AT HIGH MULTIPLES
THOMAS HYDE | JUNIOR INVESTMENT RESEARCH ANALYST
Valuing a company tends to be an art rather than a science. Investors use various metrics, but for public companies, the Price-to-Earnings (P/E) ratio stands out as the most popular. In this article, we will discuss what the number tells us about a company’s future prospects, how it can reflect the optimism of the market and the narratives driving current valuations.
The P/E ratio takes a company’s share price and divides it by Earnings Per Share (EPS), calculating the profit attributable to one share. It reflects how many years of earnings are
needed to match the current share price, assuming constant earnings. For example, a stock trading on a P/E of 20x would take 20 years of earnings to pay back the cost of the share. But a low P/E doesn’t necessarily mean a bargain, and a higher P/E isn’t always overpriced. Instead, these numbers reflect investor sentiment. When investors are confident in a company’s growth prospects, they are often willing to pay a premium for its shares, as they believe future earnings will support today’s price over time. To deliver this growth, a company must sell more, increase profitability on what it already sells, or both. This may involve offering a superior
product, expanding into different regions or keeping costs under control. Yet, companies rarely act in isolation. Large profits attract competition, which must be defended to maintain growth. Just as castles used moats for protection, companies build moats to defend their market share. A moat can come in various shapes and sizes: a pharmaceutical firm may use patents to sell a drug without competition, or a railway company may own the tracks it runs freight on. These strategies are employed to ensure dominance in a particular industry.
At that valuation, investors expected perfection.
Using moats effectively can result in a consistently high P/E ratio. These companies often enjoy entrenched market positions, allowing them to generate high returns on capital and deliver steady growth. Their predictability is attractive to investors who seek lower volatility and resilient earnings. For example, Visa and Mastercard utilise network effects, where the value of their services increases as more users and merchants join. Their high margin business model produces consistent earnings, which some argue justifies the higher valuations. Similarly, Microsoft’s subscription software generates recurring revenue. Subscribers are sticky as the services integrate into users’ workflows, making it difficult to switch. So long as such companies continue to reinvest in their business models to sustain growth and defend their moats, investors are willing to pay a premium for their durable business characteristics.
Novo Nordisk is a cautionary tale of growth without a moat. The Danish pharmaceutical company has historically delivered diabetes care, providing expertise and a revenue stream to invest heavily in research. Its weight-loss drugs, Ozempic and Wegovy, performed in clinical trials and competitors were left catching up. Supplying to a growing slimming market sent sales skyrocketing and investors priced in future performance. In 2024, Novo Nordisk was Europe’s most valuable company with a market cap of over US$600bn. Investors were so confident of its market dominance that its valuation peaked at nearly 50x P/E in June 2024. At that valuation, investors expected perfection. However, the company fell short. Growth slowed sharply in 2025 as market share was eaten away by Eli Lilly and other insurgent competitors, contributing to a steep drop in the share price. Despite growth, the company fell short of high expectations. At the time of writing, Novo Nordisk’s share price has fallen over 60% since June 2024 and it trades at just under 14x P/E, a stark reminder that turbocharged growth can falter as quickly as it rises.
In the case of Novo Nordisk, the company at least reported positive sales growth. But for high-multiple stocks, an earnings decline can trigger a double whammy of lower profits and declining multiples. That’s what happened in the dot-com bubble of the early 2000s. Investors marvelled at the internet’s potential to reshape our lives. And they weren’t wrong, it did. However, many of the era’s companies had little or no earnings, valued only on revenue growth and a dream. When investors finally realised the tremendous growth rates, they had priced were never going to materialise, the bubble burst. Valuations collapsed and sentiment turned. Many companies were wiped out and even the profitable companies saw their market cap collapse because of their ridiculous valuations. There are echoes of this pattern in today’s markets. AI is offering investors the chance to participate in the development of a new technology with fantastic potential. Companies are reaping the reward as they trade on sky-high valuations, buoyed by the potential for future revenue growth at the hands of investment in data centres, battery storage and power generation. Only time will tell whether the valuations are right or it’s another climb down from a market that loves a good story.
Overall, investing at high multiples carries upside and risk. Investors may benefit from the compounding nature of earnings growth, however, they must also be prepared for growth to slow, especially if a company fails to defend its market position. Elevated valuations may even be speculative if not underpinned by sustainable fundamentals.
Please note that this communication is for information only and does not constitute a recommendation to buy or sell the shares of the investments mentioned. Investments and income arising from them can fall as well as rise in value. Past performance and forecasts are not reliable indicators of future results and performance. The information and views were correct at time of writing but may have changed at point of reading.
