In 2023, when the Rolls-Royce Holdings (LSE: RR.) share price hit the 200p level, I thought it had reached fair value. But then it went up and up, and broke 300p. I could have had a quick 50% gain in just a few months.
The big question for me is am I wrong again? And how much higher can Rolls-Royce shares go in 2024?
Business strength
Rolls-Royce has rather brilliantly pulled its business back from the brink of disaster. It was able to get the cash needed without too much trouble. And that will be at least partly down to the long-term strength of its business model.
Servicing aero engines is a big money spinner. And Rolls is one of the few big players in a business that enjoys huge barriers to entry. Can you imagine trying to start up a similar business from scratch today?
Wonderful company
Billionaire investor Warren Buffett famously said: “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price“.
Wonderful companies can indeed command high prices. But can I ignore the share price altogether, and just buy because it’s a great company?
No, absolutely not. At least, I never would. Even the best companies in the world face risk, and it’s often from things outside of their control.
Risk premium
When I buy a stock, I want confidence that I’ll get returns in line with the risk. And the more the risk, the more I’ll want bigger returns in excess of any risk-free investment.
That’s where valuation comes in. It always does. It just has to. Forecasts put Rolls-Royce shares on a price-to-earnings (P/E) ratio of 31 for FY 2023. With the results due on 22 February, that’s probably accurate.
I see one problem though. I’d rate it as fair value in the absence of any major risks. But I can see at least two.
Global threats
The first is that the outlook for global air travel is far from assured. Look around the world today. Do we see peace and tranquility? Far from it. It seems like there’s a fresh conflict nearly every time I switch on the news.
The erratic price of fuel is another part of that external threat. And it’s all stuff that Rolls-Royce has no control over.
It feeds into my second risk. I’d be happy with the stock’s valuation, if I was confident that forecasts for rapid earnings growth are accurate. But I see too much uncertainty. And even a slight failure when it comes to meeting those goals could send the share price down again.
Buy on the dips?
I might be wrong. And to answer my headline question, I see a fair chance I’ll be back here in the future saying: “And now look, it’s soared above 400p, and I missed out again“.
But I just don’t see enough safety margin. I do think it’s a wonderful company. But it’s one I’d only buy on any future share price dips.
