If I’d invested £5k in Rolls-Royce (LSE: RR) shares in July 2022, I would have a holding worth just under £25k today.
Sadly, I didn’t buy in 2022. However, I could consider buying today. The stock market has no memory, after all. Rolls-Royce’s share price may continue to rise, if its performance is good enough.
City analysts certainly seem optimistic. Broker forecasts suggest Rolls’ annual profit will rise by 42% to £1.7bn over the next couple of years, as the company’s turnaround continues.
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Are Rolls-Royce shares too expensive?
These growth forecasts look impressive to me. But this is one of the most closely covered companies on the UK stock market. The outlook for Rolls isn’t exactly a secret.
Given that stock markets always try to look forwards, I would argue that a lot of this forecast growth is already priced into Rolls-Royce shares.
This view seems to be supported by the stock’s valuation. Rolls shares currently trade on a 2024 forecast price-to-earnings (P/E) ratio of 30, falling to 24 in 2025.
That’s a fairly strong rating. It’s certainly well above average for the FTSE 100.
Strong trading
Strong market conditions often justify a premium rating. Rolls-Royce’s latest trading commentary suggests to me that the firm does have a good pipeline of work.
Large engine flying hours are expected to rise above 2019 levels in 2024, for the first time since the pandemic. This should drive an increase in maintenance activity, which is a key source of profit for the business.
New engine deliveries are on track to rise to 500-550 this year, from 458 in 2023. In addition to providing an immediate boost to sales, these extra engines will require regular maintenance.
What about the company’s competitors?
When I’m reviewing a company, I often find it useful to see how its competitors are performing – and how they’re valued.
In this case, French engine maker Safran trades on a 2024 forecast P/E of 29, falling to 24 in 2025. That’s very similar to the valuation of Rolls-Royce shares.
US giant RTX (which owns Pratt & Whitney) is trading on a 2024 forecast P/E of 19, falling to 17 in 2025. That’s a bit cheaper than Rolls or Safran.
However, RTX is a larger and more complex business, and profit growth is expected to be slower. So this might explain the more modest valuation.
Would I buy?
To sum up, I think Rolls-Royce is in good shape and has a strong outlook. I also think there’s a chance of further profit upgrades, if air travel remains strong.
Rolls-Royce’s defence business is another potential source of growth, and could receive a boost from increased government spending.
My only real concern is that all of this is already known.
Billionaire investor Warren Buffett once said: “You pay a very high price in the stock market for a cheery consensus”. I think that could be true here.
In my view, Rolls may need to deliver more positive surprises to justify further share price gains. I’m not sure how likely this is.
If I was investing £5k in a new stock today, I’d prefer a situation where there was more obvious value than I can see here.
For this reason, I’m not interested in buying the shares at the moment.
