Image source: Rolls-Royce plc
Almost exactly a year ago, one of my colleagues at The Motley Fool asked: “When will the Rolls-Royce (LSE: RR.) share price hit £4?“
The answer, it turns out, was March 2024. Since then, with a 140% gain in the past 12 months, Rolls-Royce shares have gone on to soar through £5.
So at 529p at the time of writing, will they reach £6, and when?
No assumptions
First, I must stress that I never assume any stock will reach any specific price. I’ve been waiting a long time for the Lloyds Banking Group share price to reach £1, for example.
But what we can do is look at the things that might push it to a specific target. And then think about ways in which the wheels might come off.
And the first bullish thing I can say about Rolls-Royce is that it just keeps delivering.
In August’s first-half update, CEO Tufan Erginbilgic was in his usual mood of unbridled enthusiasm. “Our transformation of Rolls-Royce into a high-performing, competitive, resilient, and growing business is proceeding with pace and intensity,” he said.
And who doesn’t want pace and intensity?
Revenue, profit, margins… all climbing strongly. Underlying basic earnings per share (EPS) soared by 83% (even if statutory EPS fell).
Reasons to be fearful
Against that, I worry about what will happen if, one quarter, Rolls fails to beat analyst forecasts. To keep the bullishness going, it might need to smash through forecasts, rather than simply keep up with them
I often wonder if growth stock investors follow a mantra that says what goes up keeps going up. It does seem to be the way analysts set their price targets. Every time a share price goes up, they lift their target a bit more. Is that how they do it?
But if a growth stock does keep going up, that’s only until it doesn’t.
And if my experience over the years is anything to go by, when the bulls decide to move on to the next big thing, the price can drop like a sack of spuds.
Valuation
But then to turn back to the bullish side again, I still think the Rolls-Royce valuation looks attractive, even after the price climb.
We’re looking at a price-to-earnings (P/E) ratio of 31 for the current year, or around twice the long-term FTSE 100 average. But analysts expect earnings to rise by 33% between 2024 and 2026, which would drop the P/E to to 23.5.
And I reckon that might be sustainable. If the next set of Rolls-Royce results excites the market again, I think we might see £6 in the next 12 months. That price would mean a P/E of 31 for 2025. There’s a trading update in November.
Is it cheap?
The problem I have is that I might see Rolls shares as fair value now. But they’re not dirt cheap, and I really don’t see much of a margin of safety. So I won’t buy, because the risk is too high for me.
But if Rolls keeps beating expectations? This time next year, might we be asking when it will reach £7, £8, or more?
