Rolls-Royce (LSE: RR) shares have performed outstandingly well for a while. Indeed, anyone who had the foresight to buy at the beginning of 2023 would now have doubled their money.
Today, I’m asking whether this can continue.
Profits surge
The extent to which trading at Rolls has recovered is eyebrow-raising.
Earlier in August, the aero-engineer announced half-year underlying profit of £673m. This was over five times higher than over the same period in 2022.
That, in itself, would probably have been enough for holders. However, the company went on to raise its guidance on full-year profit to £1.2bn-£1.4bn (from £800m-£1bn previously). This was way above what analysts were expecting.
FTSE 100-beater
Seen in this light, the share price performance makes sense. Go back a full 12 months, however, and the return would be even better — over 150%!
That’s the sort of gain one is more likely to see from a speculative small-cap stock, not a whopping great FTSE 100 company.
Even more impressive is that there have been no significant pullbacks during this period. Rolls has just continued, well, rolling.
Speaking of the top-tier index, it’s worth mentioning that the FTSE 100 is down 1.5% (as I type) since August 2022. Yes, dividends would have improved this return slightly. But the overall result is the same: Rolls-Royce has trounced the market, demonstrating how lucrative stock picking can be over simply buying a fund that tracks the index.
Analysts are (hyper) bullish
As someone who had serious concerns about Rolls’ ability to shrug off its pandemic-related woes, I can’t help but be impressed. Further gains can’t be ruled out either.
Despite a cost-of-living crisis, it seems that people are prioritising travel over all other discretionary spending. That’s good news for airlines and, by association, for Rolls-Royce.
Analysts certainly remain bullish. Investment bank UBS recently upgraded its price target on Rolls-Royce shares from 200p to 350p. It believes the aforementioned guidance is “conservative” and estimates that profit will actually hit £1.5bn with free cash flow near the top end of £900m-£1bn.
In the best-case scenario, UBS believes the stock could hit 600p!
With this in mind, Rolls’ current valuation — a price-to-earnings (P/E) ratio of 24 — might turn out to be a steal.
Reasons to be cautious
However, there continue to be a few things that make me wary of buying in.
From a macro perspective, ongoing concerns about the state of the Chinese economy are worth bearing in mind. The company might continue to execute its transformation plan perfectly from here and yet still fall in value if global markets collectively wobble.
Should this happen, I wouldn’t be compensated for staying put. Rolls hasn’t paid a dividend for a very long time.
I’m also mindful of comments from no-nonsense CEO Tufan Erginbilgic. Earlier in the month, he reflected that a business doesn’t just improve in a straight line. Moreover, the rate of improvement tends to be higher in the early stages of the recovery.
Whether those ‘early stages’ have now passed is open to debate. However, I think this is a prudent approach. The question is whether the market will listen enough to keep its expectations in check.
If it doesn’t, there could be some serious profit-taking on the horizon.
