I look at Rolls-Royce Holdings (LSE: RR.) shares this year, and I wonder what the next few years might hold.
The price has climbed strongly since the 2020 stock market crash.
What next?
But how much further might Rolls-Royce go?
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We all wonder ‘what if’, don’t we? It can, at least, help us quantify our thinking. And that can be valuable.
So, I look at the factors I feel might boost my returns. And I think there are, essentially, three.
All gains will come from a combination of share price rises and dividends, so maybe that’s only two? Well, I see two key drivers of share prices.
One is the actual performance of the company, and the rises in earnings that result from that. The other is investor sentiment. The effects of the two can vary a lot over time. And in case you’re wondering, I’ll get to the third factor later.
Weighing or voting
Renowned value investor Ben Graham, once made an observation, summed up by one of his most famous followers.
Ben said: “In the short run, the market is a voting machine but in the long run it is a weighing machine.”
Warren Buffett, letter to Berkshire Hathaway shareholders, 1987
What this suggests is that investor sentiment will have more effect in the short term, while a cool, calm, evaluation of a firm’s performance will drive long-term valuation.
There’s no denying that sentiment has been very positive this year — the shares have trebled in just the past 12 months.
But I think that could prove a drag on future performance.
Forecasts
Broker forecasts show rising earnings from Rolls in the next few years. But they put the stock on a price-to-earnings (P/E) ratio of 36 for this year. That’s well over twice the FTSE 100 average.
It could drop to 20 by 2025 if forecasts are right, but that’s only if the share price goes nowhere.
So that’s two things, earnings and sentiment.
The third is dividends. And they don’t look likely to add a lot in the next five years, with a forecast yield of only around 1% by 2025.
If they should average out at that 2025 figure over the next five years, it could add around £500 to a £10k pot starting today.
Many FTSE 100 stocks look set to beat that in dividends just this year alone.
Bottom line?
What effect five years of earnings growth might have, I just don’t know. But it looks to me like the next two or three years could already be built into the share price.
The short-term voting is ahead of the long-term weighing.
If the P/E falls to 20 by 2025 and stays there, might we see a further 15-20% rise in the share price in the next five years?
Perhaps my £10k could grow to between £11.5k and £12k, plus another £500 in dividends? That’s just a wild guess, and I might be completely wrong.
What will I buy?
But right now, I see Rolls-Royce shares as at least fully valued, even though I like the long-term prospects.
My 2024 investing money will go into companies with good earnings growth forecasts and decent dividends. And ones where the market is more bearish, but in my view wrong.
