Rolls-Royce’s share price still looks around 50% undervalued to me at £4.33

Rolls-Royce’s share price looks set for strong growth as it joins the elite ‘investment grade’ of global firms, with a major undervaluation still in play.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Image source: Rolls-Royce plc

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Looking at Rolls-Royce’s (LSE: RR) share price, I am reminded of a key lesson from my years as an investment bank trader.

Just because an asset has risen sharply in price does not mean it will not keep going higher.

Its steep price rise might have come from investors playing catch-up with the fair value of a company. Or the firm might just be worth more than it was before. Or it may be a combination of both.

Should you invest £1,000 in Rolls-Royce right now?

When investing expert Mark Rogers has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for nearly a decade has provided thousands of paying members with top stock recommendations from the UK and US markets. And right now, Mark thinks there are 6 standout stocks that investors should consider buying. Want to see if Rolls-Royce made the list?

See the 6 stocks

In any event, the share may be worth a lot more than even the current elevated price implies. And this is the case with Rolls-Royce, I believe.

Can it really be undervalued?

discounted cash flow modelling using several analysts’ figures and my own shows the company to be around 50% undervalued.

Therefore, given the current price of £4.33, this would mean a fair value for the share of £8.66.

Created with Highcharts 11.4.3Rolls-Royce Plc PriceZoom1M3M6MYTD1Y5Y10YALL22 May 201922 May 2024Zoom ▾Jul '19Jan '20Jul '20Jan '21Jul '21Jan '22Jul '22Jan '23Jul '23Jan '242020202020212021202220222023202320242024www.fool.co.uk

There is no guarantee it will reach that price, of course, but it looks well-supported by key share valuation measures.

For example, on the price-to-earnings (P/E) valuation metric, Rolls-Royce trades at just 15.1.

This is the lowest in its peer group, the average P/E of which is 29.7. This comprises BAE Systems (at 22.2), General Dynamics (24.3), Northrop Grumman (32.2), and RTX (40.1).

How has it been performing?

The company’s 2023 results showed underlying operating profit up 144% — to £1.59bn from £652m in 2022.

To me, this explains much of the 178% share price gain over the past 12 months. Long-term fund managers and shorter-term traders would have been factoring in improving company performance ahead of time, in my experience.

This profit drove a 154% increase in free cash flow year on year – from £505m in 2022 to £1.85bn last year.

Over the same period, Rolls-Royce’s return on capital more than doubled – from 4.9% in 2022 to 11.3% in 2023.

Is it poised for further growth?

A risk for the company is that another pandemic would cripple its civil aerospace revenues (comprising 45% of its business). Another is that a major problem in any of its key defence sector products would be very costly to it.

However, in its December 2023 Investor Presentation, Rolls-Royce announced its intention to become a higher-value investment-grade company.

It has since achieved that, having secured investment-grade status from all three major credit ratings agencies — Standard & Poor’sMoody’s, and Fitch.

This ratings status will give it more preferential access to capital, which can then be used to drive further growth.

To maintain this coveted ranking, Rolls-Royce has laid out key performance targets, all of which indicate significant expansion ahead.

By 2027, it intends to be generating operating profit of £2.5bn-£2.8bn, operating margin of 13%-15%, and return on capital of 16%-18%. It also aims for free cash flow of £2.8bn-£3.1bn by that time.

Will I buy it?

I have another stock in the same sector, and I am happy with that.

However, if I did not have that, there is no question I would buy Rolls-Royce today. It still looks extremely undervalued to me and looks set for stellar growth in my opinion.

5 Shares for the Future of Energy

Investors who don’t own energy shares need to see this now.

Because Mark Rogers — The Motley Fool UK’s Director of Investing — sees 2 key reasons why energy is set to soar.

While sanctions slam Russian supplies, nations are also racing to achieve net zero emissions, he says. Mark believes 5 companies in particular are poised for spectacular profits.

Open this new report5 Shares for the Future of Energy — and discover:

  • Britain’s Energy Fort Knox, now controlling 30% of UK energy storage
  • How to potentially get paid by the weather
  • Electric Vehicles’ secret backdoor opportunity
  • One dead simple stock for the new nuclear boom

Click the button below to find out how you can get your hands on the full report now, and as a thank you for your interest, we’ll send you one of the five picks — absolutely free!

Grab your FREE Energy recommendation now

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.

Simon Watkins has positions in BAE Systems. The Motley Fool UK has recommended BAE Systems 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.

More on Investing Articles

Investing Articles

14.2% dividend yield! Is this FTSE income stock worth considering in 2025?

This clean energy trust offers the highest dividend yield in the FTSE 350 right now, but is the double-digit payout…

Read more »

Investing Articles

£5,000 invested in the S&P 500 at the start of 2025 is now worth…

2025 has been a bumpy ride for the S&P 500, tumbling towards a correction before falling further on tariff news…

Read more »

Investing Articles

£10,000 invested in the FTSE 250 10 years ago is now worth…

The FTSE 250 has been an underperformer over the last decade, but some of its stocks have delivered explosive returns…

Read more »

Investing Articles

£10,000 invested in the FTSE 100 10 years ago is now worth…

Even after multiple crashes and corrections, the FTSE 100 has still delivered impressive returns for long-term investors since 2015.

Read more »

Investing Articles

How much would a Stocks & Shares ISA investor need to invest each month to retire comfortably?

Here's how much a Stocks and Shares ISA holder may need to spend each month on UK and US shares…

Read more »

Young mixed-race woman jumping for joy in a park with confetti falling around her
Investing Articles

10.1% and 12.9% dividend yields! 2 ETFs to consider for a second income

Looking for ways to target a dependable second income in uncertain times? These ETFs could be just the ticket, says…

Read more »

Older couple walking in park
Investing Articles

Could £300 a month invested in US and UK shares reach a million by retirement?

Could an investor retire with a million pounds just by dedicating £300 a month to US and UK shares? Mark…

Read more »

Young Caucasian man making doubtful face at camera
Investing Articles

Is £800 enough to start an ISA?

Is it worth bothering with an ISA with less than £1,000 to spare? This writer believes it may be --…

Read more »