The Rolls-Royce (LSE: RR.) share price has been a big FTSE 100 success story, there’s no doubt of that.
It’s quadrupled in two years, and is up 33% in five years.
But if I held Rolls-Royce shares, I’d be getting nervous now. I’d wonder if a correction might be in the pipeline.
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Correction, or crash?
In stock market terms, that’s generally considered a fall of at least 10%.
And if we should see a 20% dip, I’d call that a crash. And Rolls-Royce shares would still be up 250% in the past two years.
So might we see a 10% correction, or even a 20% crash, in 2024?
Let’s see how forecasts put the stock’s valuation in terms of price-to-earnings (P/E) ratio and dividend yield (DY). And how either of these two fall scenarios might affect it.
Forecast valuations
| Based on… | 2024 P/E | 2025 P/E | 2026 P/E | 2024 DY | 2025 DY | 2026 DY |
| Current share price | 27.8 | 23.5 | 20.6 | 0.67% | 1.1% | 1.6% |
| With 10% correction | 25.2 | 21.3 | 18.7 | 0.74% | 1.2% | 1.8% |
| With 20% crash | 23.1 | 19.6 | 17.2 | 0.80% | 1.3% | 1.9% |
I have to ask myself one key question. How would I see the valuation of a stock with a forecast 2026 P/E of 17 and a dividend yield of 1.9%?
Well, that P/E would be above the FTSE 100’s long-term average, and the dividend yield well below average.
It wouldn’t look like a screaming buy to me. And that’s even if the Rolls-Royce share price should fall by 20%.
Growth premium
If a valuation is hiding strong growth expectations, a higher P/E could well look attractive. And even the P/E of a bit under 21 that we could see with no share price falls could be a bargain.
And today, investors do seem to expect strong growth in Rolls-Royce earnings in the next few years.
With the firm’s 2023 results, CEO Tufan Erginbilgic was, I think it’s fair to say, ebullient. He spoke of record performance, step change, improvement, focus, and sustainable growth.
And he said: “We are unlocking our full potential as a high-performing, competitive, resilient, and growing Rolls-Royce.”
Super sentiment
That’s all great. But when a CEO sounds that upbeat, it rings alarms bells.
It’s because there’s one thing that drives a share price more than anything in the short term — sentiment. And Mr Erginbilgic’s words do seem to have helped keep market sentiment buzzing.
It drives momentum, and that pushes the share price up through broker targets, and they keep raising them.
It’s almost as if their reasoning just goes: “It’s reached our target, so we’d better up it a bit.“
Safety margin
I really don’t know if the Rolls-Royce share price will fall in 2024. And if nothing takes any shine off the optimism, it could end the year even further ahead.
I’m just not seeing a safety margin here in case it doesn’t go 100% swimmingly well. Or in case fickle sentiment should shift to another stock or sector.
That’s all I’m saying.
