Could the Rolls-Royce share price be above 500p by the year end?

Jon Smith questions whether the Rolls-Royce share price could push higher if upcoming results look good, but balances it out with valuation concerns.

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The 183% jump in the Rolls-Royce (LSE:RR) share price over the past year has grabbed a lot of attention. At 418p, the rally has moderated over the past month as investors take a breather. Yet with some key events taking place between now and the end of the year, there’s scope for the stock to move even higher if things work out.

The case for 500p

One of the main catalyst for the potential move to 500p would be a strong set of half-year results, due to be released in August.

For example, from 2022 to 2023, the operating profit margin doubled from 5.1% to 10.3%. Operating profit itself went from £0.65bn to £1.6bn (more than double!). Across the board, similar financial metrics jumped. Therefore, the move in the share price closely tied in with this.

If the half-year results show a continued improvement towards the management mid-term targets, I could see the stock increasing in value further. To get to 500p, this would be just under a 20% gain. I don’t think it’s out of the question to see operating profit jump by this much based on current momentum.

Further, the enterprise value of Rolls-Royce is currently £37.4bn. This is higher than the current market-cap of £35.3bn. If upcoming results show that assets have increased or liabilities have dropped, the enterprise value could rise.

Over the mid-term, the market-cap should be similar to the enterprise value. So for the market-cap to increase, the share price would need to rally. I don’t think it’s out of the question to see that cap at around £42bn, which would mark a 20% increase from current levels.

Why the stock might fall

On the other hand, there are reasons for the stock to head in the other direction. For a start, a lot of enthusiasm and expectation has fuelled the rally so far. The bar for further gains is now very high.

Therefore, if Rolls-Royce misses growth expectations later this year, we could see some short-term investors pull the plug.

Let’s also not forget that the price-to-earnings (P/E) ratio is now pretty high at 30.60. When I compare this to my benchmark fair value of 10, there’s certainly a case for thinking that it could be overvalued above 400p.

Finally, the UK general election’s likely going to take place this autumn. Rolls-Royce have contracts outstanding with the government via sectors like defence. If there’s a shake up in leadership and budgets for some areas gets cut, Rolls-Royce shares might fall as investors get cold feet.

The balancing of the scales

I think it’s unlikely the stock will reach 500p by the end of the year. This is mostly down to the valuation, given the strong rally over the past year. Yet on the other hand, I don’t expect a massive fall either.

My base case is steady financial results that will see the share price tread water around current levels, allowing the P/E ratio to move to a more sustainable figure. On that basis, I think there are better opportunities to buy elsewhere.

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.

Jon Smith 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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