As an investor, there is little like a missed opportunity to set one’s teeth on edge, even if rationally that is not a useful thing to do. Take Rolls-Royce (LSE: RR), for example. Since the start of this year, the Rolls-Royce share price has soared 57%. That came on top of the FTSE 100 aeronautical engineer being the best performer in the index last year.
Lately, though, the shares have lost a bit of altitude.
Having traded above £5 last month, the price fell back a bit this week after engine trouble at Asian airline Cathay Pacific made some investors nervous.
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For now, details are limited although from what has been reported it seems that for affected engines this is a quickly fixable issue rather than something that could drag on for far longer.
Still, with a share that has shown the momentum Rolls has of late, any fall can sometimes be a buying opportunity. So, should I now add Rolls-Royce back into my portfolio?
Back to basics: how to value shares
To answer my own question, what I need to establish is the same as with any share.
In short, I look at what I think is a fair value for Rolls given its long-term business potential, then compare that to the current Rolls-Royce share price.
Just because a share has shot up does not necessarily mean that it is not still undervalued. After all, at the end of last year I might have thought to myself that since Rolls was 2023’s best performing FSTE 100 share, it no longer offered value. But since then it has gone up by more than half again, even accounting for the recent fall.
When it comes to valuing the shares, I see a lot to like. Demand for both new engine purchase and the servicing of existing engines is high. There are only a few companies that have the expertise to deliver what customers want. Rolls is one of them and its competitive advantages include a host of patented technology, deep know-how, and a large installed base of engines.
That has led it to set ambitious, medium-term financial targets. Over the past year and a half its performance has suggested that it could achieve them. If it does, I think its current valuation still looks reasonable.
Why I won’t be buying
However, as an investor I like a margin of safety (and as a passenger, even more so!)
The past week’s wobble in the Rolls-Royce share price shows what can happen when something goes wrong with a single engine. Given that Rolls typically has thousands in the air at any given moment, that is bound to happen from time to time.
Other factors are outside the firm’s control. Specifically, I am nervous about any sudden unanticipated downturn in passenger demand hurting its civil aviation business.
That brought the company to its knees in 2020 and I do not think the current price offers me sufficient margin of safety against such a risk manifesting itself again.
So, I do not see a buying opportunity for my portfolio.
