What a year it’s been for the Rolls-Royce (LSE: RR) share price. It’s up a staggering 224.18%, easily the best performer on the FTSE 100 too. Second-placed Marks & Spencer Group‘s shares are up ‘just’ 119.15% in 2023.
Rolls-Royce shares measure up against those racy US tech stocks that everybody loves. Chip-maker Nvidia only won by a whisker, rising 238.87% over the year. Meta trailed with growth of 183.76%. Tesla managed a paltry 101.72%.
More growth to come?
A shoot-the-lights-out momentum stock like Rolls-Royce generates extreme emotions. As ever, fear and greed are prominent, with investors torn between hoping the Rolls-Royce share price will continue to rocket in 2024 and dreading a costly crash.
Those who didn’t buy Rolls-Royce are likely to feel another strong emotion that can skew judgement – regret.
I’ve felt most of these emotions, having bought Rolls-Royce shares just before they took off in October 2022 (yay!). Sadly, I only invested a small sum (boo!). I banked a 189% gain (yay!) three months ago only to see the stock climb another 35.3% (boo!). As ever, there’s only one question that matters. Would I buy Rolls-Royce shares today?
The company has healthy prospects, as CEO Tufan Erginbilgiç hikes prices on its aircraft engine long-term service agreements, at the same time as pursuing a £400m-£500m cost reduction programme.
On 11 December, Citi lifted its price target on Rolls-Royce shares from 294p to 431p, while upping its earnings per share forecasts by 27% in the short term and 52% in the longer run. Today, the shares trade at 299p, so there’s plenty of room for growth. Citi also highlighted the group’s “very strong” cash generation.
It’s worth recalling that Rolls-Royce posted a £294m loss in 2021, followed by a mighty £1.5bn loss in 2022. As ever, investors are buying the future, and that certainly looks brighter.
Erginbilgiç is now targeting achieving operating profits of between £2.5bn and £2.8bn by 2027, plus free cash flow of £2.8bn and £3.1bn. Today, operating margins look thin at 5.8%. He hopes to widen them to 13% to 15%. These are aspirations, of course, rather than achievements.
It’s very expensive now
The long-term story is promising but in the short term, I’m wary. Rolls-Royce shares now trade at a dizzying price-to-earnings ratio of 153.7. That makes it the most expensive stock on the FTSE 100, by far. Second-placed Melrose Industries trades at a P/E of ‘just’ 81.1 times. As a benchmark, the index trades at 9.5 times earnings.
Like those mega-cap US tech stocks, there’s a serious overvaluation risk here. All it will take is one disappointing number for investors to beat a sharp retreat.
There’s also a question over how Rolls-Royce will hit its ambitious growth targets while simultaneously slashing staff numbers by 11,500. Was there so much fat in the company?
Erginbilgiç talks a good game, but next year we’ll see if he can deliver. I won’t buy Rolls-Royce shares at today’s overheated valuation, but wait for calmer skies.
In the meantime, I’ll continue to load up on cheap FTSE 100 shares trading at less than 10 times earnings and (unlike Rolls) paying dividends. I doubt any will take off like Rolls-Royce has just done, but they won’t be as risky as it looks today.
