Rolls-Royce (LSE: RR) shares have rocketed almost 175% in a year which makes them easily the best performer on the entire FTSE 100. Second-placed Centrica grew ‘just’ 96% in that time, while third-placed 3i Group climbed 64%. That’s dramatic outperformance.
The aircraft engine maker is turning into our very own Nvidia, smashing the market and turning heads. It also puts new investors in a tough position. Should they leap on board or accept they’ve missed out on one hell of a ride?
C’mon you high rollers
The danger with a stock like this is that it ends up being driven by momentum alone, until the shares become dangerously overpriced. Rolls-Royce shares now trade at a staggering 111 times earnings. That’s not as pricey as Nvidia, which trades at 250 times, but it’s way beyond what I’d normally consider.
On closer inspection, the forward valuation isn’t so daunting. That’s because earnings are expected to rise strongly. Its price-to-earnings ratio for the 2023 financial year is a more acceptable 27.3 times earnings, falling to 22.1 for 2024.
Full-year 2022 revenues totalled £13.52bn. In the first half of this financial year, underlying revenues hit £6.95bn and analysts expect a full-year total of £14.47bn. Sales are expected to jump again in 2024, to £15.46bn.
First-half operating profits more than quintupled to £673m while last year’s £68m cash outflows have turned into £356m of positive flows. UBS reckons they could hit £2bn as soon as 2024, which is when markets expect the dividend to resume, with an initial 0.64% yield.
Personally, I’d rather the board used the cash to pay down debt faster and help Rolls-Royce recover its investment-grade rating, which will boost the share price, too. There’s been plenty of progress on that front, happily, with net debt cut from £3.25bn to £2.85bn in the first half. By 2024, markets expected it to slip below £1bn.
It’s hard to say no
I’ve rarely seen a stock transform so quickly, with so many negatives turning into positives. Momentum isn’t the only thing driving the share price, positive news flow is helping, too. No wonder the share price keeps powering along. It’s up 45% over the last three months and 15% over one.
Rolls-Royce is also benefiting from hopes that we are inching closer to peak interest rates. That’s still hanging in the balance, though. Another concern is that a lot of future growth has been priced in, and if Rolls-Royce falls short of expectations, today’s euphoric investor sentiment could quickly reverse.
Yet the outlook is bright with flying hours set to rise further, defence orders likely to carry on growing as geopolitical tensions rise and the prospect of Rolls-Royce carpeting the UK with a fleet of pocket nuclear plants.
I’ve had mixed feelings about its share price success given that I bought a stake in Rolls-Royce right at the start of its strong run, but only a small one. I’ve been wary of buying more in case sod’s law kicks in and it immediately crashes, but now it seems rude not to back this resurgent British company.
I buy shares for the long-term, with a minimum target holding period of 10 years. Over such a timescale, I’d expect Rolls-Royce to power up so there’s little point waiting to buy it.
