3 reasons why I’m avoiding Rolls-Royce shares like the plague!

Rolls-Royce shares trade on a meaty price-to-earnings (P/E) ratio of 30 times. Royston Wild thinks this leaves them in danger of a price collapse.

| More on:
Frustrated young white male looking disconsolate while sat on his sofa holding a beer

Image source: Getty Images

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

A sustained recovery in the aviation industry has powered Rolls-Royce (LSE:RR) shares through the stratosphere. The engineer’s shares are up 151% in the past year alone.

With a profits-boosting restructuring continuing, too, I wouldn’t be surprised if the Rolls share price keeps on rising. City analysts are forecasting strong earnings growth all the way to 2026, which, if correct, could underpin further price gains.

YearAnnual earnings per shareAnnual growth
202417.98p31%
202521.16p18%
202624.62p16%

That said, there are also potential stormclouds coming the company’s way. And with a forward price-to-earnings (P/E) ratio of 30 times, signs of weakness could cause the share price to slump.

I’m not prepared to buy the FTSE 100 engineer, and especially at current prices. Here are three reasons why.

#1: Supply chain strains

Let’s talk about supply chain issues in the aerospace industry first. Several engineers (including Rolls itself) have warned of the threat to sourcing parts throughout 2024. Senior even warned on profits last week due to supply problems hitting deliveries at Airbus and Boeing.

Today, Rolls was in the crosshairs after IAG-owned British Airways said it had cancelled hundreds of long-haul flights. This was due to “delays to the delivery of engines and parts from Rolls-Royce“, the airline told Reuters, adding (rather worryingly) that, “we do not believe the issue will be solved quickly“.

Rolls has previously warned that supply-related problems could endure for two years. While it has said “we are proactively managing” such problems, Monday’s news suggests it may be finding the challenge a tough one.

#2: Tech issues

Product failures are a constant threat to engineers. Unfortunately, Rolls has also been in the news related to hardware issues affecting fuel nozzles in the Trent XWB-97 power unit.

Last month, Cathay Pacific grounded dozens of planes after an engine issue on one of its Airbus A350s forced it to turn around mid-flight. The European Union Aviation Safety Agency (EASA) ordered an investigation of Trent XWB-97 units in the aftermath, the results of which could be released soon.

EASA has described the tests as “precautionary“, but an adverse result could be hugely damaging for Rolls’ profits, not to mention its reputation.

#3: Civil aviation slowdown

My final concern for Rolls relates to the broader state of the civil aerospace market.

Defence revenues remain strong and look set to remain so as the geopolitical landscape worsens. The company could also see revenues rise as countries ramp up construction of small modular nuclear power plants.

However, the Footsie firm still relies on strong engine and aftermarket service demand from airlines to drive earnings. And news from some major carriers (like Delta and American Airlines) has been less encouraging of late as the post-Covid travel boom fizzles out.

This cooldown could continue, too, if the US and Chinese economies struggle for traction. Rising oil prices might also exacerbate the downturn if the crisis in the Middle East worsens.

I don’t think these threats are baked into Rolls-Royce’s sky-high valuation. So I’d rather buy other UK shares right now.

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.

Royston Wild has no position in any of the shares mentioned. The Motley Fool UK has recommended Rolls-Royce Plc and Senior 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.

More on Investing Articles

Illustration of flames over a black background
Investing Articles

Just released: November’s higher-risk, high-reward stock recommendation [PREMIUM PICKS]

Fire ideas will tend to be more adventurous and are designed for investors who can stomach a bit more volatility.

Read more »

Young female analyst working at her desk in the office
Investing Articles

Here’s how I’d target a £23k second income with £300 a month

If I was building a shares portfolio today, here's how I'd go about it. With these strategies I stand a…

Read more »

Investing Articles

Tesla stock, MicroStrategy: here’s what Hargreaves Lansdown investors bought last week

MicroStrategy and Tesla stock were among the most popular investments last week as Donald Trump boosted markets with his election…

Read more »

Investing Articles

1 AI stock worth considering now Stocks and Shares ISAs are safe!

The Budget brought good news for those of us with Stocks and Shares ISAs! I’ve been looking at this one…

Read more »

Engineer Project Manager Talks With Scientist working on Computer
Growth Shares

Up 41% in 1 year, I’m buying more of this growth trust for my Stocks and Shares ISA

A great performance over the last 12 months has pushed our writer to buy more of a very exciting investment…

Read more »

Investing Articles

3 reasons to like the Legal & General dividend

Christopher Ruane explains a trio of reasons why he likes the Legal & General dividend as a source of passive…

Read more »

Investing Articles

Down 16%+, here’s 2 unloved FTSE 100 shares for savvy investors to consider!

These FTSE 100 shares have slumped in the past six months. Royston Wild thinks long-term investors should pay them close…

Read more »

Girl buying groceries in the supermarket with her father.
Investing Articles

Down 15%, but the FTSE 100’s J Sainsbury has a dividend yield over 5%!

Is it time to consider shares in FTSE 100 supermarket chain J Sainsbury for a potentially enduring stream of chunky…

Read more »