Are these brokers right to hike their Rolls-Royce share price forecasts?

Jon Smith explains why some brokers have increased their target for the Rolls-Royce share price but flags up some of his concerns.

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Image source: Rolls-Royce plc

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Over the past couple of weeks, a couple of banks have lifted their price targets for Rolls-Royce (LSE:RR). Let’s not forget that the Rolls-Royce share price has already jumped by 200% over the past year. Yet at 448p, it’s clear that some think the stock is due to head higher still over the next year. Here are my thoughts.

Potential for more gains

Let’s start byconsidering the details of the broker price changes. Deutsche Bank and the research team upgraded their forecast to 555p. Jefferies went one step further and raised their price target to 580p.

These are just forecasts, with brokers and banks not always being correct. But given the amount of research and detail these teams go into, there are clear reasons behind their thinking.

For example, the team at Deutsche Bank said that their “degree of confidence in the company’s ability to deliver on its transformation programme has increased.” This is referring to the long-term transformation plan that the CEO Tufan Erginbilgic helped to put in place when he took over as CEO in early 2023. The drive to cut costs and revitalise key divisions is seen by many as the way that the share price can rally in coming years.

Why I’m not convinced

When I wrote about the stock in May, I concluded that I struggled to see it hitting 500p by the end of this year. I still hold to this view, despite the recent broker upgrades.

The price-to-earnings (P/E) ratio is currently at 33. I just don’t see this as being good value and think that it looks expensive in the short term. This is true when I compare it to the average P/E ratio of the FTSE 100 but also to peers. For example, BAE Systems has a current P/E ratio just above 20.

Further, there’s the concern about buying a stock that has rallied so far so quickly. It’s now at all-time highs thanks to the jump in the past year. It’s only natural that some investors will use this opportunity to realise some profits by selling the stock. From that angle, we could see a fall in coming months as investors pause for breath.

Still positive in the long run

To be clear, I’m not trying to write off Rolls-Royce at all. I think in the long term the stock could do really well and eventually climb above 500p. This is based on the financial benefits already seen since the transformation. The business managed to finally post a profit in 2023 after the large losses experienced during the pandemic. Based on the outlook going forward, it’s in a much more stable position than where it was even a year ago.

But I won’t be buying right now based on the broker forecasts. I think they’re a little bit overly optimistic to have raised the forecasts to such lofty levels. I think the stock’s overvalued and so naturally should correct lower in coming months. I’ve set an alert for it if it drops below 400p, which I think is a level at which I’d start to get interested.

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 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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