The Rolls-Royce (LSE: RR) share price has tumbled 23% so far this year and it’s dipped below £1. Does this mean the shares are a screaming buy? Here’s what I’m going to do.
A potential recovery
It wasn’t that long ago when the Rolls-Royce share price was over 300p. This was back in 2019, so pre-Covid. However, the stock was crushed when the pandemic unfolded and the airline industry was pretty much shut down. If the share price rose back to that 300p level though, I’d triple my money if I bought the shares today.
Tripling my money does sound appealing. But for this to happen, a company really does have to perform exceptionally well. So, before I buy any shares, I’d have to be confident that Rolls-Royce really can go on a post-Covid recovery boom.
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However, I’m a Foolish buy-and-hold investor. I want to own shares of companies that I’m happy to hold for the very long term. Therefore, I also need to be confident that Rolls-Royce is the best place to invest my hard-earned money beyond the recovery period. That’s especially so as there are many other companies to choose from.
Risks ahead
I do see some risks ahead for Rolls-Royce that make me doubt a quick recovery is on the cards. For a start, Covid is still around — particularly in in China — and this may limit demand for flying. International business travel isn’t expected to fully recover until 2024 either.
There’s also been churn in the management team recently. The CEO is stepping down, and the president of the Power Systems division is also departing. This brings some uncertainty into the business.
Rolls-Royce is also carrying a lot of debt on its balance sheet, which was £7.5bn at the end of 2021. This could be a drag on any potential dividend payments for shareholders going forward.
Growth drivers
There are always risks with any investment, so Rolls-Royce is no different. On the other hand, I do see international travel improving. In turn, demand for Rolls-Royce’s leading engines should increase as well.
The UK’s recent plans to boost nuclear power could also be a huge growth driver for Rolls-Royce’s reactor business.
Should I buy?
Yet while I do see some potential upside, I’m still not keen on buying Rolls-Royce shares today.
For one, the forward price-to-earnings multiple is steep at 19. I don’t mind paying higher multiples for quality growth shares. However, Rolls-Royce has a wafer-thin operating margin of 3.7%, and return on capital employed is almost non-existent at only 2.6%.
There’s also no dividend forecast for this year. There are plenty of FTSE 100 stocks paying big dividends today, which makes Rolls-Royce shares less appealing.
I think there could be a recovery in the Rolls-Royce share price, given enough time. But today, I see better risk-reward trade-offs elsewhere. Therefore, I think my money would be better used to buy other FTSE 100 stocks.
