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Rolls-Royce (LSE: RR) was the star FTSE 100 stocks last year. It rose an incredible 221% to end the year at just under £3.
This has now left me with an eternal dilemma that all investors face periodically: should I buy more shares?
I was very optimistic
I bought the shares at £1.49 last year on the premise that a massive multi-year swing in the share price might have been underway.
Under the new CEO, who I have been very impressed with, I expected profits to increase due to the rebound in global flights post-pandemic. I also anticipated that debt would decline and that its defense business would benefit as geopolitical tensions increased.
Importantly, I thought the company had other areas of growth to exploit over the next decade. One notable area could be small modular reactors (SMRs), which are essentially mini nuclear power plants.
I'm still optimistic
Nothing has happened to change my mind about my investment.
During the 10 months to the end of October, flying hours for large civil engines with long-term service agreements were 86% of 2019 levels. And while net debt was still high, £2.8bn at the end of June, that figure was down from £3.2bn just six months earlier.
That said, not reducing this debt further remains a key risk in my opinion. Selling assets can only go so far before the company's growth is jeopardized. Therefore, management's medium-term free cash flow target of between £2.8bn and £3.1bn should help in this regard.
Meanwhile, Rolls' defense unit is benefiting as military budgets increase around the world.
Heading to the moon
In December it was reported that Rolls-Royce was in talks to build a series of mini nuclear power plants in Ukraine. Of course, we still don't know how the war in Ukraine will end. But I imagine that many countries will be very interested in this technology as a way to reduce dependence on imported energy.
In fact, according to the World Economic Forum, the global SMR market is expected to reach a value of up to $300 billion by 2040.
Also in December, the company unveiled a conceptual model of a nuclear space microreactor, which could be used to support a future permanent lunar base for astronauts.
It plans to have a reactor ready to send to space by the early 2030s. Naturally, this timeline depends on companies like SpaceX preparing their rockets beforehand.
Valuation
Based on earnings per share forecasts for the next 12 months, the stock is trading with a price/earnings ratio of 28, which is higher than the average for the aerospace sector (around 19.5).
For what it's worth, the average analyst price target is £3.33, about 11% higher than the current share price.
All in all, I'd say the stock isn't particularly overvalued, even after its almighty run.
To glue or twist?
As an investor, I always have to keep in mind that the FOMO (fear of missing out) of making more profits could cause me to lose money. This is an irrational but powerful state of mind that needs to be recognized.
Fortunately, I already have the shares I bought at an attractive price. So I'm sticking with those for now.
But if I didn't own Rolls-Royce stock, I would certainly consider it based on fundamentals.
