Why have Rolls-Royce shares just fell back under £4?

Shares of Rolls-Royce have finally taken a breather after their meteoric rise. Is this my chance to buy this FTSE 100 high-flyer?

| More on:
Bronze bull and bear figurines

Image source: Getty Images

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Over the last two years, Rolls-Royce (LSE: RR) shares have displayed the strongest momentum I can remember for an established FTSE 100 company. They’re up more than 300% in just 24 months!

However, such momentum can be a double-edged sword. When a share price is consistently increasing, this can attract more investors and drive it ever higher. That’s great for existing shareholders.

But this can quickly lead to overvaluation, where the share price becomes disconnected from the underlying fundamentals and prospects of the firm. And this can cause a sudden correction (a fall of more than 10%).

After recently reaching 429p, the Rolls-Royce share price has now dropped beneath 400p. Should I seize upon this dip to buy more shares? Let’s take a look.

Why is the stock falling?

As far as I can tell, there has been no news from the company to warrant the recent sell-off. And analysts remain overwhelmingly bullish. Of the 14 offering one-year price forecasts, the consensus is 447p, or 12% above the current 399p.

Only one analyst out of 17 presently has a sell rating on the stock.

Of course, brokers are often hyper-reactive to what’s going on with the share price. If it’s going up, they’ll start raising their targets, and vice versa. So some may now change their minds and turn bearish.

They remind me a little bit of those bookies at the race track who change the odds as more or less money is placed on particular horses, dogs, or whatever. It can all be a bit speculative.

More likely is that the shares are losing altitude due to reports that interest rates may be staying higher for longer than expected. In March, US consumer prices rose 3.5% from a year ago, more than expected. So there’s probably that.

Defence shares are falling

Another probable factor here is that it’s been a bad few days for European defence and aerospace stocks in general.

Shares of BAE Systems, which have also been on fire over the past two years, have pulled back 4.8% since 8 April. Meanwhile, Germany’s largest arms firm, Rheinmetall, has seen its share price fall nearly 6%.

Rolls-Royce’s defence unit accounted for almost a quarter of group revenue last year. So there’s probably this sector-wide sell-off contributing to the fall as well.

Actually, I find the timing of this drop in defence stocks somewhat surprising. Sky News today (11 April) reported that an Iran attack on Israel could be “imminent“.

Given such disturbing geopolitical developments, I can only see defence shares heading higher.

Should I buy this dip?

There’s more to Rolls-Royce than defence, of course. Its civil aerospace division has the wind in its sails, with large engine flying hours this year projected to reach (or perhaps exceed) pre-Covid 2019 levels.

Is this rosy outlook already priced into the stock, though? Probably, in my opinion. It’s trading on a forward price-to-earnings (P/S) ratio of 27.6. That doesn’t seem to leave much of a margin of safety.

Long term, I’m still bullish on Rolls-Royce stock. I’d just like to see it come down a bit more, which is entirely possible given how fickle market sentiment can be.

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.

Ben McPoland has positions in BAE Systems and Rolls-Royce Plc. The Motley Fool UK has recommended BAE Systems, Rheinmetall Ag, 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.

More on Investing Articles

Investing Articles

Are Rolls-Royce shares good for passive income?

Our writer is getting mixed messages about the Rolls-Royce dividend. But whatever happens, he thinks passive income hunters will be…

Read more »

Investing Articles

Could the Rolls-Royce share price end 2024 above £5?

As the Rolls-Royce share price continues its remarkable run, our writer considers where it might be at the end of…

Read more »

Investing Articles

UK stocks are hitting all-time highs! Yet these 2 still look cheap to me

The FTSE 100's on a roll. But it's still possible to pick bargain UK stocks, provided we know where to…

Read more »

Satellite on planet background
Investing Articles

At just under £14, can BAE Systems’ share price still be a prime FTSE 100 bargain? 

Despite its bullish price run, BAE Systems’ share price still looks undervalued to me and appears set for strong growth.

Read more »

Photo of a man going through financial problems
Investing Articles

2 dividend shares I’d avoid like the plague in today’s stock market

The UK stock market is full of high-yield dividend shares that could equate to a steady stream of passive income.…

Read more »

Abstract bull climbing indicators on stock chart
Investing Articles

£17,000 in savings? Here’s how I’d aim to turn that into a £29,548 annual second income!

Generating a sizeable second income can be life-enhancing and can be done from relatively small investments in high-dividend-paying stocks.

Read more »

Investing Articles

With as little as £300 a month invested, this stock could net £16,000 a year in passive income

Putting a few hundred pounds each month into the stock market could eventually generate a five-figure annual passive income, this…

Read more »

Black woman using loudspeaker to be heard
Investing Articles

This dividend stock could pop next week!

This dividend stock happens to have one of the biggest dividend yields I've come across -- 10.7% -- but I'm…

Read more »