Rolls-Royce’s (LSE: RR) share price has jumped 108% from its 19 March 12-month traded low of £3.88.
Such a rise might deter many investors who fear it could not possibly increase much more. Others may see the momentum as unstoppable and buy on a fear of missing out.
As a former senior investment bank trader and longtime private investor, I know neither view helps generate consistent profits over time.
My principal concern in growth stocks is whether there is any value left in them.
How much value remains in these shares?
The first part of my standard share price analysis involves comparing a stock’s key valuations with its competitors.
Rolls-Royce is undervalued at a price-to-earnings ratio of 26.7 against a competitor average of 31.3. The same is true of its 3.6 price-to-sales ratio compared to its peer group average of 3.8.
The second part of my analysis pinpoints where a stock’s price should be, based on future cash flow forecasts.
Using other analysts’ figures and my own, the resulting discounted cash flow analysis shows Rolls-Royce stock is 35% undervalued.
Therefore, the fair value of the stock is £12.42, although market forces might move it higher or lower than that.
Do the core business numbers support this valuation?
I see a key risk in the firm being that its production capacity might struggle to keep up with its fast growth. This may create supply shortfalls at some point.
That said, its full-year 2024 results released on 27 February looked excellent to me. Revenue jumped 16% year on year to £17.848bn, while operating profit leapt 55% to £2.464bn.
Operating margin increased 34% to 13.8% and free cash flow soared 89% to £2.425bn. These helped power a 48% rise in earnings per share to 20.29p.
The firm also upgraded its short- and medium-term guidance. For 2025 it expects £2.7bn-£2.9bn underlying operating profit and £2.7bn-£2.9bn free cash flow. On top of this, it has begun a share buyback — which tend to support stock prices – of £1bn.
By 2028 it aims for £3.6bn-£3.9bn underlying operating profit and £4.2bn-£4.5bn free cash flow.
How does the project pipeline look?
The firm announced a slew of major new projects in recent months. On 24 January, it announced the largest ever deal — £9bn+ — signed by the UK’s Ministry of Defence (MoD). This will cover multiple elements connected to the nuclear reactors powering the Royal Navy’s submarines.
On 18 September, Rolls-Royce SMR was named the preferred supplier for the Czech Republic’s small modular reactors project. Industry forecasts are for the global SMR market to reach $72.4bn (£55.8bn) by 2033 and $295bn by 2043.
And in its 2024 results announcement, Rolls-Royce revealed it has successfully tested its UltraFan demonstrator. This is part of its new engine design programme aimed at the new generation of narrow and widebody aircraft.
Will I buy the stock?
The only reason I am not buying the shares now is I already own other stocks in the same sector. Adding another would unbalance the risk-reward profile of my broad investment portfolio.
If I did not have these, I would buy Rolls-Royce stock as soon as possible and believe it is worth others considering too. I firmly believe the company will see robust growth ahead, which could drive its share price and dividend much higher.
