Rolls-Royce (LSE: RR) shares were trading at 98.9p at the start of 2023.
Back then, they were considered to be trading at a discount and there was plenty of optimism that the share price would start to climb higher.
Those optimists have been rewarded big time, with Rolls-Royce shares climbing by 107.9% to 205.7p since then.
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For perspective, if I’d invested £10,000 at the start of 2023, I’d have £20,790 today. My money would have more than doubled, which is more than great for an investment less than a year old.
This poses important questions. For example, is this incredibly rapid rise in share price justified? And is it likely to continue?
Why has the share price exploded?
If we look at Rolls-Royce’s half-year results, we can see why investors have been driving its share price up.
Both the top and bottom lines impressed. Revenue increased to almost £7bn in the first half of 2023, up from £5.3bn last year.
At the same time, profit before tax turned from a loss of £111m last year to a profit of £524m this year.
Furthermore, Rolls-Royce displayed better management of its debt and cash flow.
Net debt fell from £3.3bn to £2.8bn between the end of 2022 and the first half of 2023.
Cash flow also turned positive, from an outflow of £68m last year to an inflow of £356m this year.
Management expects this trend to continue and has raised its guidance, igniting further investor enthusiasm towards the stock.
Is this justified?
Is that fair? I believe so.
Yes, debt levels are high, but these are falling at a fast pace.
There isn’t much else negative to say about the above.
However, investors should note that even though I’d have more than doubled my money if I’d invested at the start of 2023, Rolls-Royce shares are incredibly volatile.
Had I invested £10,000 five years ago, I’d have just over £7,000 today, losing almost 30% of my money.
More drastically, if I’d invested at the start of 2014, I’d only have just over £4,700 today, losing almost 53% of what I put in.
Long-term investors, like myself, should be wary of this if they were to consider buying its shares.
Where do the shares go from here?
Some would argue that a lot of the good news surrounding Rolls-Royce is already priced in to its shares.
With a forward price-to-earnings ratio (P/E) of 20.8, its stock is certainly not cheap.
However, when presented with a great company that’s growing fast, I think its valuation isn’t so important, as it can potentially grow into this.
Rolls-Royce management is looking to cut costs by cutting up to 2,500 jobs. That’s bad news for its staff but should hopefully raise profit for the company, which would ultimately lower its P/E and make its shares better value for money.
If it continues executing well, as it has been doing recently, its shares may not return the same sky-high returns they achieved in 2023, but they could be rewarding to investors.
