Have Rolls-Royce shares peaked?

After a strong run in the first nine months of the year, Rolls-Royce shares are now pulling back. Have they peaked? Edward Sheldon provides his take.

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Rolls-Royce (LSE: RR.) shares have had a great run this year. Year to date, they’re up about 100%.

However, after rising above 230p in mid-September, the share price has pulled back a bit lately. This begs the question – has it peaked?

Major turnaround

There’s no doubt that Rolls-Royce – which was hammered during the pandemic – has turned things around recently.

Thanks to its transformation programme (and the recovery in the civil aviation market), it reported an underlying operating profit of £673m for the first half of 2023. That was more than five times the figure reported a year earlier.

It also upgraded its full-year profit forecast to £1.2bn-£1.4bn, from previous guidance of £800m-£1bn. The market had been expecting £934m.

High valuation

Yet looking at the Rolls-Royce share price today, I do wonder if it has run as far as it can in the short/medium term.

One reason I think it may have is that the company’s valuation is now quite high.

With analysts expecting earnings per share (EPS) of 9.15p for 2023, the forward-looking P/E ratio is currently about 22. That’s way above the market average, indicating that the stock is expensive.

Now, Rolls-Royce could come out and smash EPS forecasts when it posts its full-year results. This would make the stock look less expensive.

However, it’s worth noting that CEO Tufan Erginbilgic recently said that the company’s transformation programme was “front loaded“.

[The] rate of improvement is not linear therefore shouldn’t be extrapolated, because early on, [the] rate of improvement is normally high,” he told reporters on a call a few months back.

So, looking ahead, the programme may not have the same kind of results, in terms of helping the company beat earnings forecasts, that it had over the last 12 months.

Broker activity

Another reason I think the share price may have topped out is that brokers have stopped upgrading their EPS forecasts (broker EPS upgrades can drive a company’s share price higher).

Over the last month, the consensus EPS forecast for 2023 has remained flat. That compares to an increase of around 3.4p per share over the last three months.

It’s also worth mentioning broker price targets. Currently, the only major broker with a price target that’s higher than the current share price is JP Morgan. It has a target price of 235p.

Most other brokers have targets that are around, or lower than, the current share price. For example, UBS has a target of 200p while Barclays has a target of 156p.

The fact that broker price targets are not higher could limit gains.

Bearish share price patterns

Finally, looking at the chart, the stock has fallen significantly below its 50-day moving average recently. This suggests that the short-term trend (upwards) could be over.

It has also formed what looks like a small ‘head and shoulders’ pattern. This type of pattern typically indicates a bullish to bearish, or uptrend to downtrend, reversal.

Time to look at other opportunities?

Putting this all together, my view is that Rolls-Royce shares have probably peaked for now.

I could be wrong, of course, but to me, it looks like the stock’s momentum is fading.

The good news, however, is that plenty of other UK stocks are still rising.

So, it could be a good time to look at other opportunities.

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.

Ed Sheldon has no position in any of the shares mentioned. The Motley Fool UK has recommended Barclays Plc. 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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