Rolls-Royce shares keep on climbing. Here’s why I’m staying away

Rolls-Royce shares have been standouts in the past year for price gains. But Oliver Rodzianko doesn’t think the stock is a wise investment now.

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Image source: Rolls-Royce plc

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The Rolls-Royce share price has risen 189% in just the last 12 months. If I’d bought some of the shares a year ago, I’d be more than pleased.

However, not only did I not make a purchase back then, but I’m convinced I’m too late to the party. In fact, I’d even consider getting in at the present valuation a gamble rather than an investment. Here’s why.

Pandemic rebound

Since the pandemic hurt the company, it’s done a good job of coming back fighting. For example, it has massively improved efficiency by cutting thousands of jobs. It also streamlined its operations as a result of the reduced demand for air travel and new aircraft engines.

With its aviation sector hit hard, the company doubled down on its defence and power systems segments. In particular, the defence sector has provided resilience to economic hardship through ongoing government and military contracts.

These efforts have clearly been working as free cash flow has jumped a whopping 280% in the last year. However, does that mean the results are likely to continue?

Buying for the long-term

I’m an investor who focuses on over 10-year investment periods. After all, Warren Buffett made his wealth that way, and I’m confident he’s a great person to listen to for investing wisdom.

Based on Buffett’s approach, I think Rolls-Royce is just too expensive now for what it’s really worth.

For example, the company will need to hit 20% earnings growth on average every year over the next 10 years to justify the current price based on the discounted cash flow analysis method.

It’s rare for even the highest-growth tech companies to maintain such high earnings expansion, let alone a company like Rolls-Royce that’s been around since 1904.

A bubble

My feeling is that as the price has risen so much at this point, it could come crashing down. In investing, we often refer to this as a stock-market bubble bursting. It’s almost impossible to tell when, but if the financials can’t justify the price, it’s usually only a matter of time.

Also, I have to bear in mind it’s got negative equity at the moment. If there’s one thing I tend to make sure I do when investing is to look for a stable balance sheet. Unfortunately, Rolls-Royce doesn’t have that.

I’m not risking it

Even if the share price does keep rising, I’m not a fan of taking on lots of risk as an investor. If I did, I’d feel like I was gambling rather than investing.

This is why I’m a big advocate of value investing. Using that method, I look for great companies that are selling for less than they’re worth. That means even if bad things happen to the company, I have some margin of safety in the price I bought it at.

I wish Rolls-Royce shareholders well, but if I’d bought the shares a year ago, I’d be thinking about selling now. At the current valuation, I’m not buying a stake.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Oliver Rodzianko has no position in any of the shares mentioned. The Motley Fool UK has recommended Rolls-Royce Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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