It goes without saying that Rolls-Royce (LSE: RR.) shares have performed magnificently in the last couple of years. In fact, even those buying at the start of 2024 would still have enjoyed a stellar return.
Today, I’m pondering whether this eye-popping positive momentum can continue.
Market beater
As market’s opened up after the Christmas and New Year break, the engine maker’s stock was at 298p. At the close on 28 June — the last trading day of the month — the very same shares were trading for 457p a pop. That’s a phenomenal 53% return, especially good for such a huge company.
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Let’s put that in perspective. Over the first half of the year, the FTSE 100 gained just under 6%. While pretty healthy in itself considering how awful the UK’s top tier has performed in recent years, this shows how successful stock-picking can rapidly grow one’s wealth.
Obviously, ‘successful’ is the key word here.
More gains ahead?
After such a rich vein of form, it’s natural to question how long this can carry on.
Interestingly, a number of brokers remain very bullish on the shares. For example, Jefferies recently set a new price target of 580p. If this came to pass, we’d be looking at a gain of 26% from where the stock sits as I type.
Now, this is just an estimate. Price targets can be modified and often are based on news flow.
Still, I don’t see why this target can’t be hit if no-nonsense CEO Tufan Erginbilgiç’s transformation plan continues to bear fruit, operating profit keeps rising and debt keeps keeps falling. It’s worth remembering that he’s still only been at the company since January 2023.
Reasons to be wary
But assuming anything is guaranteed to happen in the stock market is a big mistake.
What’s worth noting is that the shares now trade at a forecast price-to-earnings (P/E) ratio of 30. Considering that the average valuation across the FTSE 100 is less than half of this, one can argue that Rolls-Royce is now priced to perfection.
The problem is that any failure to meet those lofty expectations, even only slightly, could hit the share price hard. Regardless, it doesn’t feel unreasonable to assume that the shares will pause for breath at some point. And what effect might this have on the psychology of its owners?
Another thing to highlight is the income stream. Analysts have the company down to resume dividend payments in this financial year. If this were to happen, the amount of cash we’re talking about would be pretty negligible.
This means shareholders won’t receive much in the way of compensation for their loyalty if the share price were to tank. For that reason alone, I’m not a buyer at this level.
Interesting times
Now, I don’t mind admitting that I was sceptical of Rolls-Royce’s recovery potential a few years ago. However, the company is clearly in a far better state than it once was, supported by a more general post-pandemic recovery in travel.
On the flipside, the more the stock keeps rising the greater the risk of an eventual pullback, in my opinion. And this is before we’ve even considered how the next government’s economic strategy may impact sentiment in UK shares as a whole.
It’ll be an fascinating second half, that’s for sure.
