Is Rolls-Royce’s share price a brilliant bargain or an investment trap?

The Rolls-Royce share price offers terrific value at first glance. But does its low valuation suggest something is rotten with this investment?

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Middle-aged white man pulling an aggrieved face while looking at a screen

Image source: Getty Images

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

The Rolls-Royce (LSE:RR.) share price has made a lightning-fast start to 2023. The FTSE 100 enginebuilder is up 15% in value since January trading began. There’s a good chance of more terrific gains in the months, too.

Yet it’s caught my eye that its shares continue to offer excellent value despite those recent gains. City forecasters expect annual earnings to soar 477% in 2023, a prediction that leaves the company trading on a forward price-to-earnings growth (PEG) ratio of 0.1

Any reading below one indicates that a stock is trading below value.

This doesn’t necessarily mean that Rolls-Royce shares offer excellent value though. Some shares carry low valuations owing to the high risk to profits. So is Rolls too cheap to miss? Or is it pitfall for investors to avoid?

China is reopening

Loosened Covid-19 restrictions in China have blasted Rolls-Royce’s shares higher over the past month. As markets analyst Susannah Streeter of Hargreaves Lansdown has commented: “There are high hopes that China’s reopening will help herald a renewed love for long haul travel”.

She notes that looser rules will provide the FTSE 100 business a boost given “its core business of manufacturing and maintaining commercial jet engines”. Asia has become the fastest-growing aviation market in the past decade as wealth in the region has rocketed.

A scientist with China’s Center for Disease Control and Prevention predicts that 80% of the country has now been infected with Covid-19. This suggests that cases have now peaked and that a return to lockdowns is unlikely. But I’m conscious that new variants of the virus could put the country back again and hamper air travel once more.

An uncertain recovery

I’m also aware that air traffic could sink if the global economy moves into recession. This would hit the money Rolls-Royce makes from engine servicing, while weakened airline profits might also reduce orders of its power units.

Spending on big-ticket items like holidays tends to fall sharply as economies shrink. Business travel also slips as companies try to save cash.

Having said that, the worsening cost-of-living crisis has failed to stymie a strong recovery in the civil aviation sector. In fact easyJet this week raised its full-year forecasts on account of record booking days in January.

Big debts

It’s true that the profits outlook for many UK shares is plagued with danger in 2023. But what perhaps makes Rolls-Royce shares riskier than many is the size of its huge debt pile.

It had £4bn worth of undrawn debt as of September. So it needs the profits to keep rolling in to help it pay down these immense liabilities. Persistently-high debts could weigh on its investment in growth programmes like low-emission engines. They might also hamper its ability to restart dividend payments.

The verdict

The Rolls-Royce share price looks cheap on paper. But I believe the company still carries too much risk right now. With high cost inflation and supply chain problems threatening to persist, too, I’d rather buy other value stocks to try and make long-term returns.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Royston Wild has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Person holding magnifying glass over important document, reading the small print
Investing Articles

2 top FTSE 250 investment trusts trading at attractive discounts!

This pair of discounted FTSE 250 trusts appear to be on sale right now. Here's why I'd scoop up their…

Read more »

Smiling young man sitting in cafe and checking messages, with his laptop in front of him.
Investing Articles

3 things that could push the Lloyds share price to 60p and beyond

The Lloyds share price has broken through 50p. Next step 60p? And then what? Here are some thoughts on what…

Read more »

Young female business analyst looking at a graph chart while working from home
Investing Articles

£1,000 in Rolls-Royce shares a year ago would be worth this much now

Rolls-Royce shares have posted one of the best stock market gains of the past 12 months. But what might the…

Read more »

Investing Articles

Are HSBC shares a FTSE bargain? Here’s what the charts say!

There are plenty of dirt-cheap FTSE 100 banking stocks for investors to choose from today. Our writer Royston Wild believes…

Read more »

Three signposts pointing in different directions, with 'Buy' 'Sell' and 'Hold' on
Investing Articles

Just released: Share Advisor’s latest ‘Hold’ recommendation [PREMIUM PICKS]

In our Share Advisor newsletter service, we provide buy, sell, and hold guidance for our universe of recommendations.

Read more »

Investing Articles

Investing £5 a day could help me build a second income of £329 a month!

This Fool explains how £5 a day, or one less takeaway coffee, could help her build a monthly second income…

Read more »

Smart young brown businesswoman working from home on a laptop
Investing Articles

2 FTSE income stocks investors should consider buying in April

Income stocks are a great way to build wealth. Our writer details two picks she believes investors should consider snapping…

Read more »

Investing Articles

What might the 5-year price chart tell us about BT shares?

Christopher Ruane considers what clues the long-term performance of BT shares might offer him about business performance and whether to…

Read more »