Rolls-Royce (LSE: RR) shares are at it again. Last Thursday they hit a new yearly high of 486p. They’re now up by 200% in the past year, far outperforming any other stock on the FTSE 100.
And that’s only half the 400% growth since new CEO Tufan Erginbilgiç took office at the start of 2023. In that short 18 months, shareholders have turned a £1,000 investment into £5,000!
But like this year’s other major success story, Nvidia, the all-important question is — will it keep going?
Reclaiming losses
Much of the recent price growth has been recovery, reclaiming losses made during the pandemic. The price is only now getting close to pre-Covid levels. This may be great for investors who bought the dip but others are only just being made whole. Who knows where the price would be now if it weren’t for the ravages of the pandemic? Major US broker Citi thinks it should be higher, recently raising its price target for the stock to 555p.
With that in mind, I don’t think it’s entirely unrealistic to believe the price could climb further.
Unlike Nvidia, it hasn’t gone parabolic to a price point way above any previous highs. Furthermore, the price is being driven by more than just AI hype. The popularity of Erginbilgiç and his aggressive turnaround plan is certainly a big factor. This, combined with rising air travel and increased defence spending, goes a long way to justify the growth.
But the higher it climbs, the harder it gets.
Market frenzy
The massive growth means the sentiment around Rolls is now a bit frenetic. Most shareholders have a lot to lose so they’re eyeing the stock with a microscope. The company’s 2024 first-half results are set to be announced on 1 August and will undoubtedly command much attention. There’s a good consensus among analysts that earnings could decline, doubling the current price-to-earnings (P/E) ratio to 32. That would be well above the industry average of 25.
Even the smallest slip-up or slight earnings miss could send a wave of panic through the markets, prompting a flash sale. If I weren’t already a shareholder I would wait until after the results before considering the stock. It may still make some gains between then and now but if results are bad, they could all disappear quickly.
Other options
Overall, I’m glad I got into Rolls-Royce when I did. Even a slight decline from here leaves me in a good position. But if I were looking for some serious growth, I wouldn’t buy the shares at this level. Especially as there are many other options out there.
When it comes to the defence industry, a smaller player like QinetiQ looks more appealing to me. With earnings expected to increase, its forward P/E ratio is only 17. And using a discounted cash flow model, analysts estimate the price to be undervalued by 42%. Another alternative is Chemring Group. Its trailing P/E ratio of 33 is expected to fall to 19 — indicating strong earnings growth expectations.
