When I go back to the basics of investing, it really comes down to the level at which I buy and sell. This will determine whether it was worth the risk to buy shares at the time for the reward offered. For Rolls-Royce (LSE:RR) shares, I could buy now at levels below 100p. On a historic basis, this looks attractive, but is it a risk worth taking?
The case for buying now
Over the past year, Rolls-Royce shares have fallen by just over 9%. This might not seem like a lot, but if I extend this to three years I can see that the share price is down by 69%. This might spook some people, but I actually see this as a reason to support buying the stock now.
The main cause for the fall from grace has been the impact of the pandemic. This is shown by taking into account the full period of the pandemic. When I isolate the past year (when we were starting to come out the other side), I can note that the share price hasn’t been a major underperformer.
Therefore, if the impact of the pandemic is receding and we are likely to see a return to normality over this summer and beyond, the worst could be over for Rolls-Royce. I accept that this is a very broad and subjective viewpoint. But looking at the past performance and the reasoning for it does suggest that what has happened in the past has already been factored into the current share price.
For me, this limits the potential risk of buying Rolls-Royce shares now. The valuation of £7.84bn is too low in my opinion. I prefer to look at the enterprise value as an alternate measure of modelling the value of a business. The Rolls-Royce enterprise value sits at £13.04bn. So the case to buy now with a fairer future value ahead is appealing.
Why I shouldn’t buy Rolls-Royce shares
Although it might be true that the worst is over, it might not be the case that Rolls-Royce will be able to return to historic levels of profitability. The damage caused by the pandemic has been severe, and it might not ever fully recover.
For example, throughout the pandemic the business has cut costs aggressively. Some of this will help the business run more efficiently. Yet the cuts to headcount and trimming investment opportunities won’t help the business in the long run. In fact, it could be only in the years to come that it realizes the frugality has hampered growth.
Another point worth noting is that the higher levels of debt taken on during the pandemic also put the business in a weaker place. Net debt has climbed from £3.6bn in 2020 to £5.2bn at the end of 2021. Rolls-Royce shares might struggle to gain due to impact of high debt.
For me, I think that Rolls-Royce shares are a risk worth taking at levels below 100p. It’s still a risky stock to buy, but I think that the worst is now finally behind the company.
