Rolls-Royce (LSE:RR) shares have exploded over the past 12 months. The stock has more than doubled in value. However, it may have further to go.
So could buying Rolls-Royce shares today be like buying Nvidia stock back in the spring? Back then, the surging tech stock was only half way through its ground-breaking rally.
Beating expectations
Rolls-Royce has a history of beating earnings expectations, and 2023 was no exception. The company surpassed forecasted earnings on several occasions, driving the stock up from lows around 60p a year ago.
Impressive earnings have been driven by the recovery of the civil aviation sector despite geopolitical headwinds, including war in Ukraine, and the resultant higher fuel prices.
Moreover, Rolls’ two other main business segments — power systems and defence — have demonstrated stable growth amid robust demand.
Strong quarterly earnings reports have been complemented by the company’s announcements regarding its transformation programme.
CEO Tufan Erginbilgic wants to build a much leaner company. Unfortunately for some employees, this means job cuts.
Risks
Of course, no investment is risk-free. A fall in demand for air travel could really hurt the recovery. I’m not sure that’s going to be the case, with tourism demand resilient, but it’s certainly possible. Moreover, I’m a little concerned that Erginbilgic’s cost-cutting plan may see important R&D projects canned.
Attractive valuation
In March, Nvidia shares were changing hands for half the current price. So what makes me think Rolls-Royce shares could double in value from here? Well, it’s the PEG ratio.
The price/earnings-to-growth ratio is a valuation metric used to compare the relative value of two or more stocks. It’s calculated by dividing the price-to-earnings ratio (P/E ratio) by the earnings growth rate of the company — normally annualised from the five-year forecast.
Typically, a PEG ratio of less than one indicates that the stock is undervalued, as the company’s earnings growth is expected to outpace its market valuation.
Interestingly, despite the Rolls-Royce share price surging 185% over the past 12 months, the stock’s PEG ratio is currently 0.5.
A ratio of 0.5 is generally considered to be very attractive, indicating that the stock is significantly undervalued.
This means investors are willing to pay only 50p for every £1 of earnings growth expected. In other words, the stock is trading at a discount to its expected growth rate.
Using this metric, Rolls-Royce’s fair value would be double the current valuation.
Buying back in
I had bought Rolls-Royce with a weighted value of under £1, and I sold my holdings progressively as the stock surged. I now realise I should have hung on to my sizeable holding. But there’s a lot of “what if” moments when it comes to investing.
My opinion is changing regularly. But, at the moment, I’ve got Rolls on my watchlist, and I’m looking to buy back in.
