Image source: Rolls-Royce Holdings plc
Last year was excellent for Rolls-Royce (LSE: RR). The aeronautical engineer was the one who had the best performance in the group FTSE 100 index. So has Rolls-Royce stock struggled to maintain momentum this year? You are welcome. So far in 2024, the proportion has increased 84%.
That means that, after selling for pennies just a couple of years ago, the stock is now up 121% over a five-year period.
Can things continue to improve or does the price seem high?
Understand how to value companies
Consider this. Is Rolls really worth 84% more than it was in January?
Maybe it is.
After all, there is constant evidence of financial recovery at the company after a difficult few years. This gives investors confidence that the engineer will be able to achieve his ambitious medium-term goals.
However, I have my doubts. Much (though not all) of what we see now was already evident or could have been predicted at the beginning of the year.
Relative to current earnings, Rolls-Royce shares now trade at a multiple of 20. That's at the high end of what you'd typically want to pay for even a prominent blue-chip company.
I wouldn't pay that for Rolls, however, as history has shown (from pandemic-era travel restrictions to the aftermath of the 2001 US terrorist attacks) that demand for civil aviation engine sales and service may drop suddenly for reasons beyond the company's control. taking profits with it.
No margin of error
On the other hand, the future price-earnings ratio looks more attractive if we believe that Rolls can grow its earnings per share in the coming years.
That didn't happen in the first half of this year, when core earnings per share actually fell compared to the same period last year (although what the company calls underlying earnings per share grew strongly).
The company has been implementing a series of changes designed to improve its financial performance, from reshaping its business portfolio to cutting costs. In its medium-term objectives, the focus has been primarily on operating profit and cash flows. But if the business can improve them, I hope that will also help increase earnings per share.
Still, it seems to me that Rolls-Royce stock has come a long way in anticipation of that happening. That means there is little (if any) room for error on the company's part.
If it doesn't fully meet expectations, I think the dramatic rise we've seen in the stock over the past few years could start to unravel.
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However, for now that has not happened. In fact, if investor enthusiasm remains at current levels, I think Rolls-Royce's share price could rise even further from here.
However, as a risk-conscious investor, I do not like the current valuation of a company that, its history has shown, can withstand large and sporadic external shocks. I have no plans to buy.
