During 2013, I’ve looked at most shares in the FTSE 100 and graded them against these five quality and value indicators:
- Dividend cover
- Borrowings
- Growth
- Price to earnings
- Outlook
Some companies scored highly against the “business quality” indicators of level of borrowings, earnings growth record, and outlook. Others scored highly against the “value” indicators of dividend cover and price-to-earnings ratio (P/E).
Quality and value in harmony
However, the most promising investment opportunities scored well on both business quality and value indicators.
In this mini-series, I’m revisiting some of the highest-scoring shares to look at events since the original article and to assess the quality of the investment opportunity now. Some of these high-scoring firms could be investment winners for 2014 and beyond so, today, I’m revisiting aero-engine maker Rolls-Royce Holdings (LSE: RR) (NASDAQOTH: RYCEY.US), which scored 21 out of 25 in May.
On-track sales
A constant stream of contract-win announcements since May confirms the popularity of the firm’s latest fuel-efficient Trent engines. The order book is up around 15% at £69.2 billion compared to a year ago, and it seems that a continuous programme of research and development is paying off. Last year, Rolls-Royce invested £919 million in R&D.
In recent guidance for the current year, the directors expect modest growth in underlying revenue and good growth in underlying profit, with cash flow around breakeven, so my growth score remains at 5/5.
Forward earnings cover the forward dividend around three times, so the dividend-cover score stays at 5/5. Satisfactory recent trading and a cautiously positive outlook continue to score 4/5. With the half-year results, the firm revealed that an increase in debt wiped out the net cash position to leave net debt running at around 7% the level of last year’s operating profit. That prompts me to drop the borrowings-score one point to 4/5.
Valuation
Since May, the share price has wiggled about a bit but ended up exactly where it was at about 1213p. A forward P/E ratio of around 16.8 buys anticipated earnings growth of 9% and a predicted dividend yield of 2% for 2014. That rating looks ahead of expectations to me, so I’m keeping my P/E score at 2/5.
Overall, I score Rolls-Royce 20/25 against my “business quality” and “value” indicators today, compared with 21/25 back in May, the decrease due to the firm’s move out of net cash on the balance sheet to modest net debt.
What now?
Rolls-Royce continues to score strongly against my “business quality” indicators but investors have noticed such attractions and the valuation seems full. That makes a decision to invest tough to make.
