Rolls-Royce (LSE: RR) shares had an astonishing turnaround in 2023. Covid-19 left the aerospace giant beaten down, with shares falling to just 38p in October 2020. However, recovering airline footfall and strong earnings have pushed this stock all the way up to 295p today, 20 December.
On track for the best year since the company was listed in 1987, can this growth continue into 2024? More importantly, will Rolls be able to surpass its all-time high of 436p? Here’s my take.
Valuation and share forecasts
Even though Rolls-Royce has enjoyed stratospheric growth this year, it still trades on a respectable price-to-earnings (P/E) ratio of 16. Yes, this is slightly above the FTSE 100 average of 14, but for a stock that’s climbed over 200% in 12 months, it still looks pretty enticing to me.
With earnings-per-share forecasted to grow in 2024, Rolls is looking at a forward P/E ratio of 23. This would signify a price-to-earnings-growth ratio (PEG) ratio of 0.8. Usually, shares with PEG ratios of under one are considered fair value, so the fact that the stock’s P/E ratio may continue to creep up doesn’t worry me.
In addition to this, institutional investors seem to be bullish on the stock. Research analysts at Bank of America and Deutsche Bank both have price targets of 400p for Rolls. UBS has gone even higher, slapping a 431p price target on the stock. Considering this institutional optimism, it doesn’t seem out of the question that the stock could surpass its all-time high in 2024.
The pandemic left the stock with a huge debt load, after commercial airlines ground to a near halt. However, since then, the company has undertaken measures to strengthen its financial position, including cost-cutting through staff reductions. It has also divested non-essential operating units like its off-highway engines business.
Consequently, Fitch upgraded Rolls-Royce’s credit rating earlier this month. A bolstered credit rating signifies the company’s enhanced ability to manage its debt burden.
Not all sunshine and rainbows
It should be noted that much of the optimism surrounding Rolls-Royce relies on forecast data. Yes, the company has delivered material positive results, however, growth stocks tend to have a reputation of forming ‘bubbles’ when investors hop on the bandwagon. The aerospace giant will need to continue to deliver solid results if it wants to maintain this momentum.
Linked to this, Rolls shares have crept up to levels near their bullish institutional forecasts. With a much smaller share price growth forecast than other stocks, it makes me think that even a small disappointment could send the shares tumbling back down.
So, can the stock continue to grow?
In the past, I have had a habit of buying growth stocks near the top of the market. It might be personal pessimism, but I am uncomfortable buying into a stock that has just climbed 223%. That’s not to say that the growth cannot continue, but for me, the potential share price growth forecast isn’t worth the risk of buying at the top. I think Rolls still has some big momentum, but I think there are cheaper Footsie stocks out there. For that reason, I won’t be buying today.
