Image source: Rolls-Royce plc
Can anything stop Rolls-Royce (LSE: RR)? Over the past year, the Rolls-Royce share price has hit a new all-time high. Not once, not twice, but again and again – most recently last week.
Can it keep on going? If so, ought I to invest now?
This share’s soared and it’s understandable why
Of course, there are plenty of things that could stop the Rolls-Royce share price moving higher – and I will get onto them.
First though, I think it makes sense to start by trying to unpick the reason behind Rolls’ incredible run. After all, a FTSE 100 share growing by 852% in five years is exceptional performance in anyone’s book.
While it may be unusual, I think it is understandable. To start with, the baseline was low. Five years ago, the company was on its knees due to decimated pandemic-era civil aviation demand.
It was bleeding cash and selling for pennies. Incredibly, things were soon to get even worse: from an October 2000 low until now, the Rolls-Royce share price gain has been an astonishing 2,287%.
A business performing far better than before
But the real story here has been about a business turnaround, not just a low starting point for comparison.
Civil aviation demand has bounced back to a higher level than before the pandemic. Defence spending has taken on a new urgency that was hard to imagine even five years ago. Meanwhile, Rolls’ power systems business has also benefitted from strong demand growth.
On top of a far better demand picture, Rolls-Royce has set aggressive cost-cutting and financial goals that are already delivering meaningful benefits.
This all adds up to a more compelling investment case. The soaring Rolls-Royce share price has in turn created more stock market momentum, helping drive it up even further.
I’m tempted, but….
Momentum does not interest me though – I prefer to invest on the fundamentals of a business. On that basis, I do still find Rolls-Royce an attractive proposition. It is a proven business that is generating large sums of cash and looks set to do even better in coming years. Thanks to its large installed engine base, proprietary designs, engineering expertise and strong brand, I think it can perform well.
But what has put me off? Ironically, it is the soaring Rolls-Royce share price! Or, more specifically, what that price growth has meant for the firm’s valuation.
If I was to buy shares today, I would be paying 31 times earnings. For a mature company in a mature industry, that has often gone through significant financial swings in the past, I do not see that as an attractive valuation.
My primary concern is not what lies inside management’s control, but what lies outside it. Just as the pandemic and associated travel restrictions blindsided the civil aviation industry, similar future disruptions could do the same. That could suddenly hurt Rolls’ revenues and profits badly.
The current Rolls-Royce share price does not offer me what I consider an adequate margin of safety, given that risk. So I will not be investing.
