Can Rolls-Royce shares double from here?

Rolls-Royce shares have hit new heights in recent days with the share price exceeding 400p. But could we ever see it trading above 800p?

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Image source: Rolls-Royce Holdings plc

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Rolls-Royce (LSE:RR) shares have more than doubled in value over the past 12 months. The stock has delivered incredible returns for shareholders and is up 188% over the last year. So, with Rolls-Royce trading at 419p at the time of writing (midday, 21 March), could it really double from here? Could we ever expect to see Rolls trading at 838?

Momentum

Firstly, Rolls has two very attractive features for an investment. It keeps beating market expectations in terms of earnings and the stock has great momentum.

Obviously there’s no guarantee that Rolls will continue beating expectations — it has set a fairly ambitious medium-term targets which will influence market expectations — but it’s a good sign. Equally, momentum, generated by positive investor sentiment, isn’t easy to come by. In fact, UK stocks in general have been suffering from poor investor sentiment. Rolls is an outlier.

Still undervalued

Rolls-Royce still looks undervalued, even after its monumental gains. The stock is currently trading at 23.7 times forward earnings, and that’s around average for its broad peer group of aircraft engine manufacturers, defence contractors, and power systems providers.

For example, General Electric trades at 36.5 times forward earnings, Boeing at 63.3 times, BAE Systems at 20 times, and RTX Corp at 17.4 times. There’s a wide spread here and that reflects the fact that all of these business are different and the same goes for their growth rates.

Rolls is certainly among the most attractive here based on its middling price-to-earnings (P/E) ratio, its very strong growth rate, and it’s impressive economic moat. Below I’ve highlighted the P/E ratios for the next four years, however the most relevant comparison is probably with GE and RTX, which owns P&W. Of course, a more in-depth comparison would need to look at debt and other factors.

Rolls-RoyceBAEBoeingGERTX
P/E Year 123.72063.636.517.4
P/E Year 219.6242915.5
P/E Year 320.517.323.913.9
P/E Year 417.113.421.114.4
All figures are forecasted earnings

In answering our question, there’s no precedent for Rolls-Royce to be trading at double its current share price. However, that’s not to say that Rolls couldn’t trade twice as high in four or five years time, assuming the growth proposition is as strong then as it is today.

The bottom line

Rolls-Royce is currently experiencing tailwinds in all parts of it business. With the company refocusing its attention on margin as well, Rolls is an incredibly attractive proposition at this moment.

Looking further ahead, there are obvious positive trends in civil aerospace where the industry will need an estimated 80,000-90,000 engines for new aircraft alone over the next two decades.

One potential risk here is that Rolls left the narrow-body market in 2011. It stands to miss out on 80% of demand if it doesn’t re-enter this space.

So, can Rolls-Royce shares double from here? In the current growth trajectory is sustained through the medium term, then absolutely. However, there’s really very little certainty when we’re looking that far ahead.

Nonetheless, it’s current price-to-earnings-to-growth ratio suggests it could trade 30% higher.

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.

James Fox has positions in Rolls-Royce Plc. The Motley Fool UK has recommended BAE Systems 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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