Rolls-Royce (LSE: RR) was the star-performing FTSE 100 stock last year. It surged an incredible 221% to finish the year a smidgeon under £3.
This has now left me with a timeless dilemma that all investors periodically face: should I buy more shares?
I was very bullish
I bought the stock at £1.49 last year on the premise that a massive multi-year turnaround in the share price might have been unfolding.
Under the new CEO, who has impressed me a lot, I expected earnings to head higher due to the rebound in global flying following the pandemic. I also anticipated debt coming down and its defence business to benefit as geopolitical tensions heightened.
Importantly, I thought the company had other growth areas to exploit over the next decade. One notable area could be in small modular reactors (SMRs), which are essentially mini nuclear power plants.
I’m still bullish
Nothing has happened to change my mind about my investment.
For the 10 months to the end of October, flying hours for large civil engines on long-term service agreements were 86% of 2019 levels. And while net debt was still high at £2.8bn at the end of June, that figure was down from £3.2bn just six months earlier.
That said, not bringing this debt down further remains a key risk, to my mind. Asset disposal can only go so far before the company’s growth is jeopardised. So management’s medium-term free cash flow target of £2.8bn–£3.1bn should help in this regard.
Meanwhile, Rolls’ defence unit is benefiting as military budgets rise across the globe.
Heading to the moon
In December, it was reported that Rolls-Royce was in talks to build a string of mini nuclear power plants in Ukraine. Of course, we still don’t know how the war in Ukraine will end. But I’d imagine many countries will be very interested in this technology as a way to reduce reliance on imported energy.
Indeed, according to the World Economic Forum, the global market for SMRs is expected to be worth up to $300bn by 2040.
Also in December, the firm unveiled a nuclear space micro-reactor concept model, which could be used to support a future permanent Moon base for astronauts.
It plans to have a reactor ready to send to space by the early 2030s. Naturally, this timeline relies on the likes of SpaceX getting their rockets ready beforehand.
Valuation
According to forecast earnings per share figures for the next 12 months, the stock is trading on a price-to-earnings ratio of 28. That is higher than the average of the aerospace sector (around 19.5).
For what it’s worth, the average analyst price target is £3.33, which is about 11% higher than the current share price.
All in all then, I’d say the stock isn’t particularly overvalued even after its almighty run.
To stick or twist?
As an investor, I always have to be mindful that FOMO – fear of missing out – on more gains could lose me money. This is an irrational but powerful state of mind that needs to be recognised.
Fortunately, I already hold the shares I bought at an attractive price. So I’m sticking with those for now.
But if I didn’t own Rolls-Royce shares, I would certainly consider them based on the fundamentals.
