The Rolls-Royce (LSE: RR) share price has crushed every other stock on the FTSE 100 over the last year, rising 191.47%. Over the same period, the index as a whole has fallen 0.76%.
Marks & Spencer Group is the second best performer, but it’s up ‘only’ 91.37%. Rolls-Royce is smashing it. That tempts and terrifies me in equal measure. I’m torn between fear of missing out (good old FOMO) and a dread of buying into the hype.
2023’s best stock
I haven’t totally missed out, having bought a small stake in Rolls in October 2022, just before its shares hit warp speed. I sold a month ago, as I needed some cash and was happy to bank my 179% profit. The stock is up another 28.89% since then. I miss it.
After completing the transfer of some legacy company pensions into a self-invested personal plan (SIPP), I now have some cash at my disposal and I’m tempted to use it to buy Rolls-Royce shares. Or should I accept my moment has passed?
One figure worries me. Rolls-Royce shares currently trade at a blockbuster 132.5 times earnings. That’s what happens when a stock goes on a tear. By comparison, the price/earnings ratio for the FTSE 100 as a whole is just 9.2 times.
Yet on closer inspection, that valuation isn’t too terrifying. Yesterday, CEO Tufan Erginbilgic announced plans to quadruple profits to £2.5bn by 2027. He’ll also be exiting less profitable areas and raising £1.5bn from disposals. It seems a long time since he was deriding Rolls-Royce as a “burning platform” and declaring that “every investment we make, we destroy value.” It was January this year.
This stock needs a long-term view
Markets love Erginbilgic but in a way he’s been lucky. He’s benefited from contracts set up under predecessor Warren East, as well as engineering issues at US aerospace manufacturer Pratt & Whitney. The company’s net debt no longer spooks investors. It fell from £5.2bn in 2021 to £3.3bn in 2022, due to disposals and improved cash flow. That was on East’s watch.
Today, markets are really into Erginbilgic. This is reflected in the group’s forecast P/E of a more modest 35.2 times earnings for 2023 and 25.7 times for 2024. I can live with those numbers. Markets are also looking forward to dividend resumption, albeit at low levels. The forecast yield for 2023 is 0.01%, edging up to 0.58% by 2024.
The CEO has impressed by talking tough and aiming high. The risk is that he does not deliver, and profits do not quadruple. To answer my own question, yes, Rolls-Royce mania has gone too far, I think. It’s inevitable after its recent run. Today’s share price has been whipped up by lashings of speculative froth. The problem is, I was thinking the same thing a month ago.
I’m delighted to see a big FTSE 100 blue-chip generating genuine excitement. I’ll still buy it, but this time I’ll aim to hold for years and years rather than grab a quick profit and run. If the mania subsides and the stock falls, I’ll wait for the fundamentals to assert themselves.
