Image source: Rolls-Royce plc
Last year, the best performing stock in the FTSE 100 index was an aeronautical engineer Rolls-Royce (LSE: RR). This year, the company has almost achieved the same impressive feat. again. Rolls-Royce shares have soared 93% so far in 2024, on top of last year's stellar performance.
What if the company has another spectacular year in 2025?
Another 93% rise would take Rolls-Royce shares to around £11.14 each.
You wouldn't normally expect a mature, blue-chip company with a large market cap to almost double in value if it had already done so in the previous year. But the engine manufacturer did it this year. Why not the next one?
Let's explore.
Momentum and fundamentals
Nobody knows what will happen in the future in the stock market or in the case of the price of an individual stock.
But as a general rule, a couple of things that can make a stock go up or down are what's known as fundamentals and impulse.
Those factors are pretty much what they sound like: One has to do with the fundamental business prospects of a company that deserves a higher or lower share price, while the other reflects the fact that some stocks rise or fall by a streak of investor optimism or fear that It may not always be perfectly rational.
They can play off each other: Positive (or negative) fundamentals can help increase momentum in stock price movement.
But many investors take comfort in the idea that momentum tends to last less than fundamentals: over the long term, good performance will be achieved.
Rolls-Royce is a company that works well
This may be more true on the way up than down (think game stop as an example). Positive momentum can help a company raise cash, which in turn improves its fundamentals.
Conversely, negative momentum in the stock market can drive a company to the ground faster than its business fundamentals can justify.
Clearly, Rolls-Royce shares have benefited from the momentum, as fear of missing out has led investors to get in on the story. That poses a risk: If momentum shifts, Rolls-Royce shares could plunge even in the face of strong business performance.
In fact, Rolls is doing well as it has focused its business and set ambitious medium-term performance targets. It is also benefiting from strong and renewed demand for civil aviation after the challenging years of the pandemic.
Much depends on delivery
As a long-term investor, not a trader, I consider both momentum and fundamentals (as they can affect stock prices), but I make investment decisions based on how I think a company will perform.
Rolls-Royce shares are already trading with a price-to-earnings (P/E) ratio of 21. For the stock to hit £10, the P/E ratio would have to reach around 36, which is too high for me opinion. likes, or earnings per share would have to rise sharply.
I think expectations of strong business performance are already built into the price. Meanwhile, while earnings per share could benefit from the company's cost reductions and strategic focus in recent years, there are still risks.
Any sudden slowdown in civil aviation demand could severely hurt profits, and this has happened sporadically and unexpectedly in the past. That risk alone deters me from investing at the current price.
