Back in the 2020 stock market crash, I feared Rolls-Royce Holdings (LSE: RR.) shares might fall to nothing. I saw a very real chance the company could go bust with the aviation halt seriously hurting its business and a huge debt mountain building.
I got that wrong, didn’t I? The Rolls-Royce share price has soared 785% in the five years that followed. It’s a combined result from the stunningly fast development of Covid vaccines coupled with a first class workforce. And, of course, the drive that CEO Tufan Erginbilgiç has brought to the company.
To adress the headline statement, that rise would have been enough to turn every £5 invested in Rolls-Royce back then into £44.25 now. Or £100 into £885, and £10,000 into £88,500. Or… you get the picture, and it’s a rosy one.
What should we do now?
That’s all well and good. But it tells us absolutely nothing about the next five years.
Hindsight is a poor tool for making investment decisions. In fact, it’s no tool at all. I’ll always remember the words of a friend many years ago who observed: “You sure know how to pick a stock that’s already gone up“.
Rolls-Royce might make an aero engine breakthrough tomorrow that will seriously boost profits. Or it might fall slightly short of expectations in one quarter and that could send the share price tumbling.
These days, I’m seeing growing signs that investors are increasingly expecting companies to beat expectations. And just coming bang in line with forecasts can be seen as a fail. And again the shares can drop.
That could be the biggest risk right now, especially with the share price having gained so much. I’m convinced there’s a fair-sized proportion of shareholders who’ve enjoyed the ride and are looking for the first sign they should get off.
Back to fundamentals
I can see only one sensible approach to Rolls-Royce shares now. That’s to forget the past, which has nothing more to tell us. And instead look at fundamental valuations and forecasts and base our decisions on those.
Doing that, I get the feeling that Rolls-Royce could still be decent value. We’re looking at a forecast price-to-earnings ratio of over 35. And that’s well over twice the long-term FTSE 100 average. I’d put it a long way from screaming cheap.
But a couple of things make me think it really might not be much of a stretch. Firstly, earnings growth forecasts suggest the P/E could drop to around 26 by 2027. For a company with long-term growth potential, that could be attractive.
Forecasts also predict net cash of £7.2bn on the balance sheet by then. Adjusting for that, I calculate an effective 2027 P/E for the business of 23.
Anything could happen
That looks like an attractive valuation to me. But it’s perhaps sailing a bit close to the wind, and there might not be a lot of safety margin there. But Rolls-Royce shares have to be worth considering for long-term growth investors. Even if they’ve already gone up.
