At the start of this year, I did not want to invest in Rolls-Royce (LSE: RR). Rolls-Royce shares looked costly to me, having been among the FTSE 100’s top performers last year — and it was the number one riser the year before that.
Still, in under three months, my decision not to buy Rolls-Royce shares means I have missed out on a big opportunity.
So, should I now take a different approach and buy?
What I’ve missed out on — just since January!
What would an investor who had bought at the start of January now be sitting on?
Since the turn of the year, the Rolls-Royce share price has surged 31%.
So, £10K invested then would be worth £13,100 now – under two-and-a-half months later. That is the sort of return that many investors dream of.
The engineer announced last month that it was reinstating its dividend after a gap of some years. That will not be paid until June, so if an investor had bought shares in January, they would not yet have received it. In fact, they would need to keep holding the shares until the second half of April, when Rolls-Royce shares go “ex-dividend” to qualify for the payment. That means an investor buying today could still earn it.
Still, even without a dividend, turning £10K into over £13K on paper in under three months is no mean feat – especially for a share I already thought looked pricey in January.
Time to alter my investment thesis?
Not buying Rolls-Royce shares at the start of the year means I have missed out on a big short-term potential gain.
I am a long-term investor, so in itself that does not bother me. Still, such a sharp rise does raise the question – did I make a mistake and ought I now to buy Rolls-Royce shares?
My answers to those questions are: no and no. Let me explain why.
Each investor has their own risk tolerance
I recognised long before this year what great potential Rolls-Royce had as a business. It operates in a sector with high barriers to entry where reliability is paramount, so it has substantial pricing power.
Add to that a large installed base of engines, a renowned brand and some proprietary technology and there is a clear investment case here. Since the New Year I think it has strengthened. Rolls announced last month that it has hit some commercial targets two years early, set higher targets set for the medium term and is seeing strong demand from defence clients.
But it was never the investment case that put me off buying Rolls-Royce shares. For me, it was merely a question of valuation.
Billionaire investor Warren Buffett likes to invest in great businesses at attractive prices. I take the same approach.
That matters because paying too much provides too little (or zero) margin of safety. All businesses face risks – and that includes Rolls-Royce.
An unexpected event like a pandemic could hurt aviation demand overnight. This week, US airlines have been reporting weaker domestic demand due to economic uncertainty.
That poses a risk to customer demand for Rolls-Royce, over which it has no control. I do not think its current share price offers me sufficient margin of safety to mitigate that risk, so I have no plans to invest.
