At some point, the Rolls-Royce (LSE: RR) share price has to stop. It’s climbed 535% in just two years, for crying out loud. No stock can keep rising at that speed forever.
After such a magnificent run, there’s inevitably a fair bit of froth and speculation in the share price. If the get-rich-quick squad bank their profits and chase their next adrenaline hit, Rolls-Royce shares could fall at speed too.
I’m wondering if we’re at that point. The aircraft engine maker’s stock is up 133% over one year but just 10% in three months. It’s now the 16th biggest company on the FTSE 100 with a market cap of £42.2bn, one place above defence giant BAE Systems.
Rolls-Royce shares are starting to look expensive, trading at 36.38 times earnings. That’s more than double the FTSE 100 average of 15.3 times.
Is it too late to buy?
Given the impact of transformative CEO Tufan Erginbilgic’s leadership, Rolls can justify that top-end valuation. It started August by lifting full-year profit guidance to between £2.1bn and £2.3bn, after first-half underlying operating profit rose 74% to £1.15bn
First-half revenues grew 19% to £8.18bn while cost savings helped lift operating margins by 4.4 points to 14%. The group is on course to generate free cash flow of up to £2.2bn, and will reward shareholders by resuming the dividend. The shares are forecast to yield 1.08% in 2024, creeping up to 1.23% in 2025.
Much of the recovery has been driven by the post-pandemic recovery in flying. Rolls-Royce makes much of its money from aircraft engine maintenance contracts, which are based on miles flown.
Investors remain wary of airline stocks generally, as they realise what a bumpy sector this can be, vulnerable to war, terror, strike action, weather and volcanoes. Yet in the case of Rolls-Royce, investors are having too much fun to worry about that.
Is this FTSE 100 growth stock too pricey?
I could add recession to that list of troubles. If the US suffers a hard economic landing, business and consumer travel could fall and not just in the States. Given the high expectations built into the Rolls-Royce share price, even a slight revenue, earnings or margins miss could knock the share price.
Also, there’s a danger that we’re all investing too much in Mr Erginbilgic. He’s clearly done a brilliant job. But he was fortunate to take over after former CEO Warren East had navigated the worst. I like a lucky general as much as Napoleon did, but there’s a lot of hard work ahead.
Supply chain disruptions remain a worry, and looming trade wars won’t help. There’s a huge opportunity in the group’s proposed fleet of mini nuclear plants, but huge uncertainty, too. The green transition and volatile fuel and commodity prices could also drive up costs.
The Rolls-Royce share price is slowing, and I wouldn’t be surprised to see it idle or fall. I still think it’s an unmissable long-term buy-and-hold for me. I won’t be buying more shares at today’s valuation, but will definitely buy them on a dip.
