The Rolls-Royce (LSE: RR.) share price has soared, nearly tripling over the past year to breach £4.70. As the British engineering icon continues to post stellar financials and ambitious growth targets under CEO Tufan Erginbilgic, investors have piled in. But with the stock nearing £5, one question looms — can this trend really continue?
The story so far
The fundamental turnaround fuelling the rally is impressive. 2023 revenues surged 22% on the post-pandemic recovery. Stunningly, the company managed to turn a £1.5bn statutory loss into a £2.5bn profit, doubling free cash flow along the way. Newly-raised growth targets suggest to potential investors that there could be a lengthy growth runway ahead. Clearly, the market likes what it sees, with the share price now up over 195% in the last year alone.
However, that optimism appears well priced in to Rolls-Royce’s share price. At 29.5 times forward earnings — over double the FTSE 100 average, the company now ranks among the UK index’s most expensive names. Even extending to 2027 projections, the shares fetch nearly 20 times that year’s forecast profits.
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Risks
To be fair, the stellar 28% forecast annual earnings growth justifies a premium 1.04 price-to-earnings-growth ratio, considered attractive. But it also illustrates how investor expectations have become very elevated after the recent rally. Any execution stumbles or external shocks could quickly lead to some destabilising profit-taking.
Despite the strong movement in the share price, there are plenty of red flags for me. With earnings expected to decline over the coming years by about 4% annually, I’d expect there to be a little more volatility. With limited dips in the last year, I wouldn’t be surprised to see a major decline if sentiment suddenly shifted, and investors suddenly decided to take profits.
There’s also the major issue of debt. In a time of high interest rates, and general uncertainty, the company’s £4.2bn debt could make investors very nervous.
Analyst outlook
Over a dozen analysts recommend buying Rolls-Royce shares with just one Sell rating, which looks good on the surface. But their average price targets sit modestly below the stock’s current price level — possibly underestimating recent momentum, but also suggesting that a degree of scepticism lingers.
I feel like this scepticism is somewhat warranted given the firm’s history of overpromising and underdelivering growth under past leaders. Any change in economic projections, or geopolitical issues, could also impact the key defence unit.
Overall
After such a spectacular rebound, investors have clearly seen a lot to like in this company. But for me, I fear that some really critical risks aren’t being factored in to the share price, and I don’t want to be buying shares just as another major decline arrives. I’ll be steering well clear for now.
