As the Rolls-Royce share price falls, has a big correction just started?

Is the Rolls-Royce share price heading for a 20% fall? Or is there a new 20% rise on the cards? Here’s how the valuation might look.

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The Rolls-Royce Holdings (LSE: RR.) share price reached a 52-week high of 435p on 2 April, up 45% year to date.

And that meant it had more than quadrupled in just two years.

But since that peak, Rolls shares have fallen 9%, to 396p at the time of writing on 19 April. Is this the start of a price correction?

Wobble

There’s probably some profit-taking here. It often happens with growth or recovery shares. Investors will look at their gains, and just take a bit off the top.

Someone who invested £1,000 in Rolls-Royce shares at the bottom could take that much back out now… and still have around £3,000 left in. It’s like free shares.

Now, I’m not going to start shouting that the sky is falling. Even if Rolls shares should dip a bit, I still think we could be looking at a long-term buy.

But I say it pays to sit back and take a look at where the valuation might go at various price levels.

Valuation

So, here’s a table showing forecast valuations for Rolls-Royce, at different prices. I look at the peak price of 435p, the recent 396p, and then at 5%, 10%, and 20% falls from today.

And so I don’t look like a total sourpuss, I check what a 20% price rise might do. (We don’t need to see a 10% rise, as that would just take us back to 435p.)

So here’s what forecast price-to-earnings (P/E) and dividend yields (DY) could look like:

Share priceP/E 2024P/E 2025P/E 2026DY 2024DY 2025DY 2026
435p (peak)29.224.921.80.63%0.99%1.51%
396p (recent)26.622.719.90.69%1.09%1.66%
376p (-5%)25.221.518.90.72%1.15%1.75%
356p (-10%)23.920.417.90.76%1.21%1.85%
317p (-20%)21.318.215.90.86%1.36%2.08%
475p (+20%)31.927.223.80.57%0.91%1.39%
(Data sources: Yahoo!, MarketScreener)

20% fall?

That’s a wide range of valuations. And even a 20% fall in the share price from current levels would still leave Rolls-Royce on a P/E of 21.3 for 2024.

That’s about 40% above the long-term FTSE 100 average, so the shares might still look expensive. But for a stock with long-term earnings growth potential, it could be super cheap.

And upbeat forecasts could drop the P/E to 15.9 by 2026. For a top-quality growth stock like Rolls-Royce Holdings, I think that could be a steal.

20% rise?

At the other end, a 20% share price rise from today could give us a 31.9 P/E for this year, dropping to 23.8 by 2026.

And I think a good case could be made that even that’s good value for a stock with the outlook that Rolls has.

All the time, whatever happens to the share price, it looks like the dividend is just getting started. And those yields would be very strongly covered by forecast earnings.

A fall?

Whatever happens in the next 12 months, I don’t think the share price warrants a big fall. But if we get one, it could be a nice buying opportunity.

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 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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