Where might the Rolls-Royce (LSE: RR) share price be sat in a decade’s time? There is no fixed answer to this question. Not at the moment anyway. Trying to predict where a stock will trade a decade from now is almost impossible.
However, it is possible to make an educated guess based on its growth potential over the next decade.
And this is what I have been trying to do to assess whether or not the company is undervalued at current levels, based on its growth potential over the next few years.
Rolls-Royce share price potential
I think there will be two drivers for the company’s earnings over the next 10 years. The first is the state of the global aviation market.
We are already seeing some signs the industry is recovering from the pandemic. Consumers are returning to the skies, and airlines are placing orders for new planes to capitalise on rebounding consumer demand.
There is also a growing demand for new planes from the air cargo industry. This sector has experienced substantial growth over the past two years, and businesses are rushing to acquire new capacity to fulfil growing order books.
This could be a significant catalyst for the stock over the next five to 10 years. The company is one of only a handful of major aircraft engine producers globally. It is bound to experience some growth if the industry is also expanding.
At the same time, management is also spending a significant amount of time and effort developing the company’s nuclear initiative.
The group is developing so-called small-scale modular nuclear reactors, which are significantly easier to produce than traditional nuclear power stations. It has lined up £500m of financing to progress with this initiative and recently submitted its plans to the government to begin the approval process.
It is unlikely that this business will generate any profits for the company for the next decade. However, if successful, the overall market could be massive. At an average cost of around £2bn per unit, Rolls’ reactors will be significantly cheaper than traditional nuclear facilities.
Earnings growth potential
All of the above should positively impact the company’s bottom line. This, in turn, should have a positive effect on the Rolls-Royce share price.
Based on current City estimates, the stock is trading at a forward price-to-earnings (P/E) multiple of 13. That looks appropriate considering the company’s growth outlook over the next two years. That said, it does not seem to consider any growth potential over the following eight years.
In the base-case scenario, I think the corporation can increase earnings at, or above, the inflation rate. I expect inflation to average around 5% for the next decade. Based on this projection, I think the Rolls-Royce share price can return approximately 5% per annum over the next 10 years. As such, I think the stock could be worth 154p by 2032.
Of course, these are just estimates. There is no guarantee the company will achieve this earnings growth. Neither is there any guarantee it will find a significant market for its nuclear technology.
If earnings do not recover over the next few years, the stock could face significant selling pressure from investors.
However, I would be happy to buy the shares as a speculative growth play for my portfolio, despite these risks.
