The Rolls-Royce (LSE: RR) share price has taken the market by storm in the last 12 months. During that time, it has soared 175.6%.
But have investors who are considering buying shares today missed the boat? Given the hype surrounding the stock, it’s an important question to which I want an answer.
Any value left?
At 415.1p, I want to see if there’s any value left to squeeze out of Rolls stock. There are a few ways I can do this.
One is by looking at its price-to-earnings (P/E) ratio. For the upcoming year, Rolls is on 28. Compared to its peers, such as BAE Systems (20), the stock looks expensive. It’s also considerably more expensive than the average of its FTSE 100 peers (11).
Of course, simply looking at one valuation metric doesn’t paint a full picture. There are other factors I must consider.
Take market sentiment as an example. Since nearing bankruptcy in 2020, the business has staged an epic comeback. And that’s drummed up plenty of buzz about its shares.
Sentiment and investor hype can drive a stock higher in the near term. However, it’s fundamentals that are the real growth drivers over the long run. And as a potential investor, the craze surrounding the business is a cause for concern.
I reckon its relatively high P/E reading coupled with the attention focused on the stock could prompt a share price correction.
Making headway on lofty aims
But should investors really be concerned by this? After all, the performance the business has posted in the last couple of years has been magnificent. If it keeps this up, its share price may just keep rising.
That’s likely to be the case if the firm meets the targets that CEO Tufan Erginbilgic has laid out. By 2027, he aims to quadruple Rolls’ profits to £2.8bn.
In all fairness, he’s made good progress to date. Last year, underlying operating profit rose 144% to £1.6bn while free cash flows jumped 155% to £1.3bn.
Soaring interest rates have also taken the shine off growth stocks in recent times. But with cuts expected at some point this year, that could help push the stock higher.
I’d steer clear
I like Rolls and where it’s heading as a business. But I don’t deem its valuation attractive at its current price.
It looks too expensive compared to its peers and the wider market. And what’s more, unlike competitors such as BAE Systems that offer a dividend yield (2.3%), Rolls has yet to reinstate the one that it removed in 2020.
The biggest threat is that the stock gets pulled back. While it has made a strong comeback, I’m cautious that some shareholders will now be expecting the business to persist with its current sales and earnings growth, which may be difficult.
Any sign of a slowdown could be incredibly damaging to its share price. I’m not comfortable with such a small margin of safety as an investor.
It’s staying on my watchlist. Should it fall to a price I’m happier paying, I’ll consider making my move.
