One of the most popular disclaimers in finance is that “past performance is no guarantee of future returns”. This is true and investors shouldn’t blindly invest in a stock simply because it has gone up in the recent past.
However, there is also merit in looking at past events and the impact on the share price to try and forecast the future. Given the moves in Rolls-Royce (LSE:RR) shares in recent years, what could this year offer?
Looking at the past
Over the last year, the stock has fallen by 20%. Over the past five years, this figure is 69%. So when I take a five-year average return, it’s a negative 13.8%.
On the face of it, this doesn’t fill me with confidence that I should be putting £1,000 of my hard-earned money in. If my return for the next year is similar, I won’t be happy. But I also need to understand what has caused this performance slump.
The vast bulk of the share price fall over five years came with the stock market crash in early 2020. Then, as the pandemic really started to grip, Rolls-Royce shares over halved in value in a matter of weeks.
The main driver behind this was impact on the Civil Aerospace division. The need for the provision of new engines and the servicing of existing ones for major airlines dried up almost overnight. With almost zero air travel, revenue for the largest part of the group disappeared.
At the start of 2023, the business has already started to move away from having such a strong reliance on this division. It has undergone a restructure and has slimmed down some operations to reduce debt. So despite the past share price performance reflecting the pandemic, it’s now in the rear-view mirror.
Catalysts for the future
My return for this year could be positive, given that the current share price should reflect all the public bad news from the past. If 2023 proves to be a better year, then the uplift in optimism logically should pull the stock higher.
One positive catalyst could be the easing of restrictions in and out of China. Given the size and income these consumers have, I’d expect to see a surge of airplane travel. In turn, this should have an indirect benefit for Rolls-Royce.
Another factor would be an outperformance in the Defence division. In December, the share price jumped with confirmation of a US defence deal with Textron, needing thousands of engines from Rolls-Royce. Given the focus on security at the moment, more government spending globally in this regard would be good for business.
Potential returns
On balance, I think the stock could offer me a positive return this year if I invested now. This is based on the catalysts that could spark a rally. However, I’m very conscious of the poor performance tracking back several years. This could prevent investors from being confident enough to invest now. Therefore, I’m going to save my money as I think I can find a stock with a better risk/reward ratio to invest in for 2023.
