I thought about purchasing shares in FTSE 100 jet engine producer and manufacturer Rolls-Royce Holdings (LSE:RR) four years ago, but at 300p it felt too expensive. With the shares now under 90p, I can’t help but feel the current price represents a bargain now.
As a value-oriented investor, I’d only be prepared to invest in the stock if it has high growth potential at a cheap price.
Can I expect significant growth from Rolls-Royce shares?
By virtue of being in the civil aviation sector, the business should benefit from a greater volume of people flying, as well as a greater volume of flying hours in the long term, particularly where travel restrictions have been lifted such as in Europe and the Americas.
Consequently, profit is expected to more than double over the next couple of years and higher cash flow is also anticipated, which should feed into a higher share valuation. So that is a tick for growth potential.
Are Rolls-Royce shares cheap?
The company’s price-to-sales ratio is not too far behind the sector average, and this suggests the stock is already valued in line with the industry norm.
City analysts believe the shares are only trading at 12.5% below its intrinsic value. This could suggest that the stock’s growth potential, no matter how positive, may already be factored into its current valuation. From this perspective, I don’t believe Rolls-Royce stock is cheap.
A broader risk for me to consider is the cyclical nature of the company’s sales. Rolls-Royce has a tougher time selling its goods and services when the economy isn’t firing on all cylinders — which may be the case for a while yet. As a result, the stock is more volatile than others, and therefore relatively high risk for my portfolio.
The benefits for me regarding the volatility is that when the market is bullish, the price movements of the shares will be exaggerated relative to the rest of the market. Conversely, however, if the market is bearish, the company’s shares could fall by more than the market.
So, with any significant capital growth looking unlikely for me with this stock, could a high dividend yield make the shares attractive enough for me to purchase?
In a lot of cases, yes. But the fact the company hasn’t paid a dividend to its shareholders for a couple of years means that Rolls-Royce shares will serve no purpose in my portfolio.
Just because a stock looks cheap to me on face value doesn’t necessarily make it a bargain. Rolls-Royce may be a good example of this.
The sharp decline in its share price over the last three or four years may reflect a broader correction by the market, and I am inclined to think that the current price better reflects the business’s long-term potential.
My portfolio is focused on global income and growth, and this stock doesn’t look like providing me with either over the long run. One for me to avoid for now.
