Rolls-Royce (LSE: RR) shares are popular right now. Last week, Rolls-Royce was the fifth most purchased stock on Hargreaves Lansdown. Meanwhile, on Trading 212, RR is currently the 7th most owned stock overall. This interest in the stock appears to be pushing its share price up.
Is this a share I should buy for my own portfolio? Let’s take a look at the investment case.
Rolls-Royce shares: the bull case
I can see why Rolls-Royce shares are popular at the moment.
For starters, the share price has been hit hard due to Covid-19 disruption. Over the last year, RR is down about 50%. As a result, the company has a market cap of just £2.2bn right now.
If the prospects for the airline industry improve (which I think they will eventually), Rolls-Royce shares could rise. That’s because the company generates a substantial proportion of its revenues from the manufacturing and servicing of engines for the commercial aviation industry.
Secondly, there’s been a lot of talk this year about all-electric planes and ‘air taxis’ and some investors believe that Rolls-Royce could be a big player in these areas.
Recently, Rolls-Royce has been developing a high-performance electric aeroplane named Spirit of Innovation. This has completed its first runway taxiing tests, ahead of a first flight, which is expected to take place this spring.
“This system and the capabilities being developed will help position Rolls-Royce as a technology leader offering power systems to the urban air mobility market,” said Rob Watson, director of Rolls-Royce Electrical, after the tests.
This development certainly looks interesting. Going forward, air mobility could be a genuine source of growth for Rolls-Royce.
Is RR a good fit for my portfolio?
Having said all that, I’m not convinced that Rolls-Royce shares are a great fit for my portfolio at the moment.
I like to invest in companies that are consistently profitable, cash generative, financially sound, and that generate a high return on capital employed. In other words, I like high-quality businesses. Companies like Apple, Microsoft, and dotDigital are some good examples. Companies that have these kinds of attributes tend to be good investments over time.
Looking at Roll-Royce’s financial track record, it’s not so impressive. In recent years, the company has posted big losses on a number of occasions (well before Covid-19). And even when it was profitable, return on capital employed was not that high. Meanwhile, Stockopedia gives Rolls-Royce an Altman Z1 score of -0.19 which indicates a “serious risk of financial distress” within the next two years. Overall, Rolls-Royce does not appear to me to be a high-quality business.
Better stocks to buy
In conclusion, I do think Rolls-Royce shares have the potential to keep rising in the short term. If the airline industry picks up, the company should benefit.
However, Rolls-Royce is not the kind of stock I’d buy for my portfolio. I think there are much better stocks I could buy right now that are more suited to my goals (generating strong returns over the long term) and risk tolerance.
