Of all the positions in my Stocks and Shares ISA, Rolls-Royce Holdings (LSE:RR.) is currently (30 June) the most profitable.
Although I was late to the post-pandemic party, the aerospace and defence group’s shares have continued to outperform the wider market. Since June 2024, they have more than doubled in value. Over the same period, the FTSE 100’s risen by a more modest 7%.
Better late than never
My initial reluctance to buy the stock was based on a belief that the group’s shares were expensive and that the incredible bull run would run out of steam. It’s sometimes hard to believe that when the group launched its life-saving rights issue in October 2020, it was valued at £1.5bn. Today, it’s worth £82bn.
And if I’m honest, despite being my top-performing holding, I still have the same concerns.
Based on the consensus of analysts’ forecasts, earnings per share are expected to increase significantly over the next four years – to 24.7p (2025), 29.3p (2026), 33p (2027) and 37p (2028).
Depending how far ahead you look, it means the shares are currently trading on a forward price-to-earnings (P/E) ratio of between 39 (2025) and 26 (2028). This is in ‘Magnificent 7’ territory.
How should this be interpreted?
But there’s a difference between a stock that’s expensive and one that’s overvalued.
The share price of a costly one can be maintained as long as earnings continue to grow. Otherwise, there’s likely to be a sharp correction.
However, there’s no hope for something that’s overvalued.
Of course, the forecasts may be wrong. But if they prove to be there or thereabouts, they suggest Rolls-Royce shares are not overvalued. Expensive, yes. However, as long at it can grow its earnings as expected, they are not overpriced.
And with increased global defence spending and the aviation industry expected to expand steadily over the coming years, Rolls-Royce is well placed to capitalise. Further ahead, I think small modular reactors could also be a winner.
The group’s well-managed and the way in which it’s recovered since Covid is a testament to its reputation for engineering excellence and quality.
My opinion
But I don’t want to buy more of the group’s shares at the moment. Don’t get me wrong, I’m not planning on selling. However, I think much of the anticipated future growth appears to have already been factored in to the group’s current market cap.
And brokers appear to agree with me. Their average 12-month price target is 920p. The stock’s currently trading at around 5% above this level.
I also think it’s important to maintain a well-diversified portfolio. Having too much exposure to one particular stock or sector is never a good idea.
We will learn more about the group’s prospects on 31 July, when it’s due to publish its results for the first six months of 2025. Three of the past four results announcements have contained upgraded guidance. But I doubt this will be repeated this time.
However, on balance, I consider Rolls-Royce shares to be a Hold for me. As for other investors, those looking for a growth stock could consider adding it to their portfolios. But I suspect they’re unlikely to see a level of return similar to that enjoyed by those who have invested over the past five years or so.
