Rolls-Royce shares: too much, too soon?

Rolls-Royce shares were easily the best FTSE 100 stock to buy last year. But are investors now in danger of getting ahead of themselves?

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Image source: Rolls-Royce Holdings plc

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Without a doubt, Rolls-Royce (LSE: RR.) shares — and anyone holding them — enjoyed a fantastic 2023. Had I invested roughly this time last year, I’d have more than trebled my money in just 12 months.

That’s the sort of barnstorming performance I’d expect from a hot tech stock that’s unveiled the ‘next big thing’. It’s not what I’d anticipate from a lumbering FTSE 100 engineer.

Does it make sense to say that this stock has exceeded its reach and is set for a much different 2024? Possibly not.

You ain’t seen nothing yet!

One of the reasons the shares have kept motoring higher is the huge and ongoing recovery in the travel industry.

After multiple lockdowns, many of us simply couldn’t wait to get away after the pandemic. And a lot of the aircraft we boarded stayed in the air via the company’s engines which, naturally, require ongoing maintenance. All this was great news for the company’s bottom line.

One wonders whether the prospect of interest rate cuts later in the year could provide another boost to demand as discretionary spending rises. And on a more depressing note, the firm’s Defence division may also continue to benefit from protracted geopolitical tensions.

I must say that CEO Tufan Erginbilgic comes across as very impressive too. Quite frankly, Rolls-Royce was in such a state that it required a no-nonsense leader. And following job cuts and much streamlining, that’s exactly what it now seems to have.

When investors sense that they’ve got the right person at the helm and the outlook on trading is sufficiently robust, they’re more willing to stick around.

No longer a basket case

But share price movements over the near term are as much dependent on human emotions as numbers on a spreadsheet. And this is where the investment case starts to wobble for me.

It’s fair to say that the Rolls-Royce share price has galloped higher because expectations surrounding the company were arguably once as low as they could be.

Who wanted to own a company making engines that weren’t even being used? Not me. Who wanted to own a company that was drowning in its own complexity and a dollop of debt? No, thank you.

But braver contrarians believed the firm was so hated that the only way was up — so long as it didn’t go out of business. It’s an irritatingly simple idea in hindsight. And it was right.

Investors are selling…

The problem is that things are now quite different. While the City experts are projecting great growth in 2024, this seems to be more than priced in.

Rolls-Royce shares change hands for 24 times forecast earnings. That implies near-perfect execution going forward.

The trouble is that the more we expect, the greater the risk of being disappointed. And there’s currently no dividend stream to compensate for any pain if we are.

Interestingly, I noticed that the company was only the eighth most popular buy at investment platform Hargreaves Lansdown last week. It was however, the most popular sell.

One week of trading won’t tell us much. But so long as the price appears up to date with the (good) news, I wonder whether we might see more profit-taking in 2024.

Has the ‘easy money’ been made? Only time will tell.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has recommended Hargreaves Lansdown Plc and Rolls-Royce Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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