Rolls-Royce’s (LSE: RR) share price slumped to its cheapest since the height of the pandemic last week. This has encouraged healthy levels of interest from dip buyers as stock market confidence has improved.
The FTSE 100 share is, in fact, the third most-frequently purchased stock on Hargreaves Lansdown’s investment platform in recent days. Rolls-Royce has accounted for 2% of all buy orders from investors in the past seven trading sessions.
So should I also consider buying Rolls-Royce’s shares today? Or should I avoid this battered engineering stock like the plague?
A cheap share price
Rolls-Royce’s share price has collapsed by almost half during the past 12 months. Yet the company retains an enormous conventional valuation. And City analysts are predicting stratospheric earnings growth in 2022.
At current prices around 75p per share the engineer trades on a price-to-earnings (P/E) ratio approaching 150 times.
But when valued using an alternative measure — the price-to-earnings growth (PEG) ratio — Rolls-Royce shares actually look quite cheap.
Forecasters think earnings will soar 350% year on year in 2022. This creates a prospective PEG ratio of 0.4.
Investing theory says that a reading below 1 indicates that a share is undervalued.
Prolonged profits growth?
Ah, but is this year’s expected earnings surge likely to be a one-off?
Far from it. Rolls-Royce is tipped to enjoy a 600%+ earnings surge in 2023 too. And this leaves the firm trading on an even lower PEG ratio.
Based on these metrics, Rolls-Royce’s share price has plenty of scope to surge, right?
Well, it’s possible. But unfortunately, stocks face a variety of real-world threats that can throw paper forecasts windly off course. And Rolls-Royce faces several significant dangers that could leave profits forecasts in tatters.
Should I buy the shares?
For one, the post-pandemic recovery for civil aerospace is looking quite fragile as economic conditions worsen. And by extension so is the anticipated recovery in flying hours for Rolls-Royce’s aircraft engines over the next two years.
Spending on discretionary items like holidays is one of the first things to fall when consumers feel the pinch. Pressure on company profits also threatens to derail activity among business travellers.
At the same time, Rolls-Royce faces a period of prolonged cost inflation. It could also be struck by extra currency headwinds if (as many expect) the pound tanks against other currencies again. These factors saw the business slump to a £1.6bn loss in the first half of 2022.
The verdict
I think rising defence spending will provide a boost to the company’s profits. So will the firm’s heavy investment in green technologies over the longer term.
However, it’s my opinion those other threats overshadow the good stuff. And don’t forget that the company’s £5.1bn net debt pile will also hamper its ability to invest for growth. On balance, I believe Rolls-Royce shares carry too much risk for me.
