Here’s why the Rolls-Royce share price scares me

The Rolls-Royce share price has been one of the big FTSE 100 success stories of the past year. But here’s why I won’t risk any of my money.

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The Rolls-Royce Holdings (LSE: RR.) share price looks scary to me. Billionaire investor Warren Buffett once said: “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price“.

Is Rolls-Royce a wonderful company? It’s a global leader in its industry. And the management has just pulled off one of the most impressive recoveries I think I’ve ever seen.

I think it’s about as close to wonderful as a FTSE 100 stock can really get.

Fair price?

But is the share price a fair one? It actually might be, even though we’re looking at a price-to-earnings (P/E) ratio of around 33 now.

For a company priced to go bust just a couple of years ago, that’s quite remarkable.

Based on forecasts, the P/E could drop to 22 by 2025. And if Rolls achieves the growth it hopes for, that could indeed turn out to be a fair price.

But there are two main reasons I’m steering clear, and one is the market itself. What do I mean? Take a look at the Rolls-Royce share price chart:

Sentiment

It looks to me like Rolls-Royce shares have been in the firm grip of market sentiment for much of the past five years. That’s fine when it’s all doom and gloom, as it can push shares down too far and give us some bargain buys.

But when the mood’s bullish, like right now? It can lead people to think only about the upbeat possibilities, and fail to account for the risk.

If all goes well, I think Rolls shares could do well from here. But any failure to match up with hopes, even by a whisker, and I think there’s a big risk the shares could fall. The safety margin I like to see just isn’t there.

Wonderful

To get to my second big reason to avoid Rolls-Royce shares, I need to come back to what Warren Buffett said again.

And I have to ask, isn’t it surely best all round to buy wonderful companies at wonderful prices? That might not happen very often, but I think I’m seeing it right now.

I also see some among the FTSE 100‘s big banks at the moment. Look at Barclays, Lloyds Banking Group and NatWest Group.

Big dividends

They’re on dividend yields of 4.9%, 5.8% and 7.4% respectively. What about their P/E mutliples? They’re between 5.4 for Barclays, and 6.2 at NatWest.

Thats a far cry from 30+ for Rolls-Royce. Safety margin? These bank valuations look like nothing but safety.

A further dip into recession, the effects of inflation and interest rates, and growing bad debt provisions could hurt the banks. But I see far lower risk at these valuations than with the lofty share price at Rolls.

I’ve picked just the banks as examples. But I see lots of FTSE 100 companies I rate as wonderful, at wonderful share prices. I just see no need to take on the Rolls-Royce risk in a value buyer’s market.

Now, if Rolls-Royce shares should fall…

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.

Alan Oscroft has positions in Lloyds Banking Group Plc. The Motley Fool UK has recommended Barclays Plc, Lloyds Banking Group Plc, and 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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