Rolls-Royce (LSE: RR.) is the gift that keeps giving, as the share price reached new highs of 446.7p last week.
I was sure it had run out of steam in early April, but it just keeps going! It’s now up 48% this year and appears to have no intention of slowing down. It’s the top-performing stock on the FTSE 100 over the past three years, up 320%. That’s a better performance than popular US stocks like Microsoft and Tesla.
So where’s it headed this year?
Opinion seems to be divided about this year’s direction. Some people are certain it’s a bubble that will crash soon, while others believe it can keep rising. At least everyone agrees that it won’t stay where it is.
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Considering it’s a leader in its industry and is in high demand, there’s a strong case for the price to keep rising. But demand today doesn’t mean it’ll continue tomorrow.
The company makes its profit from three sectors – civil aerospace, defence, and power systems. Air travel continues to grow steadily, so its airline engines are likely to remain in high demand. Defence could taper off if conflicts in Eastern Europe and the Middle East are subdued but for now, demand also remains high. Its power systems are used in defence, agriculture and commercial fishing.
CEO Tufan Erginbilgiç appears confident in the company’s future, describing it as “high-performing, competitive and resilient”. Some major brokers feel the same, with both Shore Capital and Jefferies putting in Buy ratings recently.
But does that mean it will keep rising?
Not necessarily. The main reason the price could dip is if defence spending is cut as a result of de-escalating conflicts. Air travel looks unlikely to subside any time soon and I see no reason that demand for power systems will reduce.
But recently I’ve heard chatter of investor sentiment shifting toward value stocks. If that’s true, Rolls could take a hit if it doesn’t reinstate dividends soon. And I’ve seen several analysts with a 12-month price target below current levels.
But the biggest bear case against Rolls is simply fundamentals. With earnings forecast to decline by 50% in the coming year, the company’s price-to-earnings (P/E) ratio could double from 15.5 to 31. That would certainly put it in overvalued territory. And if a reduction in earnings results in failure to hit targets, that could shake investor confidence.
What do I think?
I agree with analysts who believe the stock should be considered overbought at this level. While there might be some growth in the short term, I think the share price will ultimately decline before the end of the year. Aside from obvious outliers like Nvidia, consistent and uninterrupted price growth is rare.
What goes up must go down, right?
And if it does, that could provide a good opportunity for investors who want to buy at a cheaper price. Because in the long term, I believe Rolls-Royce will keep delivering the exceptional service it’s famous for.
Whether it rises or falls this year, I’m in for the long haul.
