It has been a turbulent time for the aircraft engine maker Rolls-Royce (LSE: RR). Over the past year, the Rolls-Royce share price has tumbled by 49%. That means if I buy the shares today and they recover that lost ground, I would almost have doubled my money. In fact, if the shares get back to their high point from the past 12 months, I will have more than doubled my investment.
Is that a realistic scenario – and should I buy more Rolls-Royce shares today?
What goes up…
As an aerospace engineer, Rolls-Royce knows better than anyone that what goes up must come down, sooner or later. However, the old adage does not work in reverse. Just because something goes down does not mean it will ever go up again.
So simply looking at a share price chart and reasoning that there is a potential profit to be made if a share retraces its old price is not what I regard as long-term investing. It is more like trading, zooming in on the Rolls-Royce share price alone rather than trying to understand the underlying business and what is driving its valuation.
Underlying business performance
That does not mean the share price chart is useless though.
Looking at how Rolls-Royce shares have performed in recent months, what I think is interesting is that there has not been a sudden drop in investor confidence when the shares suddenly fell off a cliff.
Rather, there has a been a fairly steady downhill march with the shares continuing to lose positive momentum. I think that reflects the way the City has been thinking about the prospects for the business.
As pandemic-related restrictions on travelling were lifted, investors became enthusiastic about the outlook for aviation and suppliers such as Rolls-Royce. That helps explain why, in the past 12 months, the shares hit a high point last autumn when lots of things were reopening and demand for travel was increasing.
This year though, that optimism has run into the reality of concern about Covid-19 variants, shambolic organisation at some airports and the impact of inflation on customer demand.
I think the Rolls-Royce share price could take off
But does this investor sentiment mirror the forward-looking business prospects for Rolls-Royce?
I do not think so. Certainly the company faces ongoing challenges, from inflation eating into profit margins to uneven civil aviation demand recovery by region.
However, in broad terms, the company seems to be on a recovery path compared to where it was a couple of years ago. Its disposal programme has increased strategic focus and boosted the balance sheet. It has maintained its full-year guidance. The company has proven that it can generate profits and free cash flows after its reorganisation a couple of years ago.
I see massive long-term opportunity for Rolls-Royce, selling new engines and servicing its installed base. Against that its current market capitalisation of £6bn looks cheap to me. But for the Rolls-Royce share price to double I think the firm needs to show more evidence of sustained business recovery.
The investor mood towards travel-related stocks also needs to improve. That could take years, but I think it may happen. However, as I already own quite a few Rolls-Royce shares, I will simply hold my existing position rather than buying more.
