Are Rolls-Royce shares REALLY the FTSE 100’s greatest bargain?

Using one popular valuation metric, it seems Rolls-Royce shares might still be too cheap to miss. So should I buy it for my investment portfolio today?

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The Rolls-Royce (LSE:RR) share price has had an electrifying rise in the year to date. At 222.2p per share, the FTSE 100 engineer is currently 134% more expensive than it was at the start of 2023.

Rolls shares have paused for breath in September following these heavy gains. This is perhaps not a surprise as talk of a bubble forming around the company has intensified.

But on the other hand, based on City projections, the company still seems to offer incredible value, on paper. So now I’m once again considering whether I should buy it for my portfolio.

City analysts think its earnings will soar 329% year on year in 2023. This leaves Rolls shares trading on a forward price-to-earnings growth (PEG) ratio of 0.2.

Any sub-1 reading indicates that stock is trading below value. What’s more, the company is under this bargain benchmark all the way through to 2025.

On the up

The travel sector’s impressive post-pandemic recovery is the chief reason behind Rolls’ impressive share price rise. The company needs a lot of planes in the air as it generates vast revenues from the servicing of its large engines.

But this is not the only good news coming out of the company. Under new chief executive Tufan Erginbilgic, efforts to mend the balance sheet continue to tick along nicely following massive asset sales last year.

Price rises and cost reduction actions helped earnings swing to a meaty £524m underlying pre-tax profit in the first half, way ahead of City predictions.

Rolls is also enjoying excellent momentum at its defence division as countries embark on a new arms race. Operating profit here rose 33% in the six months to June, while £2.7bn worth of new orders were racked up too (up from £1.4m a year earlier).

Big questions remain

Theres a lot of good things going on here then. But as a potential investor there are also several major problems and potential threats putting me off buying Rolls shares. These include:

  • The possibility of fresh trouble in the commercial airline sector as the global economy splutters and inflationary pressures hit consumer spending
  • Persistent supply chain issues that may affect sales across the business
  • High cost inflation that could hamper further margin growth
  • Large net debt of £2.8bn, of which almost half needs to be repaid by the end of 2025
  • Huge R&D costs that could keep the balance sheet under strain 

I’m also mindful that Rolls shares don’t look that cheap using another popular metric, the price-to-earnings (P/E) ratio. In fact, they appear quite expensive compared to the broader FTSE 100.

As I say, brokers predict annual earnings to rise 300%+ this year. But the company still trades on a forward P/E ratio of 26.4 times. This is way ahead of the Footsie average below 14 times.

This is why, on balance, I’d still rather buy other blue-chip shares for my portfolio today.

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.

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