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He is one of Footsie's star artists after the end of the pandemic. And the Rolls-Royce (LSE:RR.) The share price shows no signs of losing steam yet.
At 331 pence per share, the FTSE 100 engineer is up 11% since the start of 2024. It continues to be driven by the flow of positive news coming from across the global airline industry.
Using a popular metric – the forward price-earnings (P/E) ratio – the aircraft engine maker now looks a bit expensive, some market commentators argue. At 26.6 times, this is more than double the Footsie average of 11 times.
But based on another widely used metric, the price-earnings growth (PEG) multiple, Rolls-Royce's share price actually looks very cheap.
At just 0.8, it is below the benchmark of 1 that indicates a stock is undervalued. This is based on the city's predictions that annual profits will soar 32% in 2024.
However, I still have reservations about buying stocks for my portfolio. What should I do next?
The case for
As I say, a series of major airline upgrades have boosted Rolls-Royce shares lately. In the last week, Air Canada has followed major US and European operators in posting strong financial results over the past year.
In fact, Canada's largest airline raised its profit forecasts for 2024 after announcing a 10% improvement in passenger numbers between December 18 and January 6.
A strong airline industry is critical to Rolls' bottom line and revenue. Almost half of its revenue came from Civil Aerospace in the first half of 2023.
Encouragingly, the outlook is also strong for its Defense division. I expect sales of their military equipment to increase as Western countries rapidly rebuild their armed forces.
The case against
But I still have problems with buying stocks today. In particular, air travel demand could disappoint in 2024, and potentially beyond, if economic conditions worsen in key regions such as the United States and China. Airline business may also stumble if interest rates fail to reverse their current levels.
And while the rise in conflict is boosting the company's defense division, it is creating turbulence for the airline industry, thus posing an indirect threat to Rolls' Civil Aerospace unit.
This bothers me as Rolls has to pay off a large chunk of its £2.8bn net debt over the next two years. Therefore, any problems in its end markets could affect the amount of cash it has to spend on its capital-intensive growth programs. It may also delay when the company can start paying dividends again.
The verdict
While Rolls-Royce stock looks cheap on paper, I'm still not convinced I should spend my hard-earned money on it.
A further slowdown in the airline industry (combined with the strain this would put on the company's balance sheet) can completely change the face of the company's investment case and cause its share price to drop dramatically.
I also don't think you have to take a big risk to get decent value. primark owner Associated British foodssportswear giant JD Sports and life insurance Aviva are just a few of the Footsie stocks that also have PEG ratios below 1 today. So I'm happy to avoid Rolls stock and buy other blue chip stocks for my portfolio.
