When it comes to soaring sky high, aeronautical engineer Rolls-Royce (LSE: RR) knows a thing or two. That has been the case with the Rolls-Royce share price in recent years, too.
This month has seen it hit a new all-time high. Over the past five years, the Rolls-Royce share price has soared 1,175%. For a FTSE 100 share (or indeed any share), that is a phenomenal performance.
But I do not own the share. Could it be worth me adding it to my portfolio now in the hope that there is more fuel left in the tank for the engine maker?
Looking at fundamentals not momentum
One common mistake investors make – including myself on occasion – is getting carried away with a share’s momentum.
Although we often hear that past performance is not necessarily a guide to future performance – and it is not – it can be hard to really focus on that when looking at a share price chart like this one.
However, it is true. A share’s momentum can help push it up further, as investors scared of missing out pile in. But momentum can change at any moment, sometimes for no obvious reason.
Over the long term, I regard a company’s business fundamentals as far more important than its share price momentum.
By ‘fundamentals’, I mean what the business has that can help set it apart from competitors in customers’ minds, its revenues, profit margins, free cash flows, and other such factors.
Lots to like about Rolls-Royce
When it comes to Rolls’ fundamentals, I think the all-time high share price reflects a lot of positive developments for the company in recent years.
For decades it was an inconsistently performing business, with long product development lead times, cyclical civil aviation demand, and variable management skill seeing it produce some bumper profits but also some huge losses.
The past several years have seen strong demand in its three key markets of civil aviation, defence, and power generation. That looks set to be the case for the foreseeable future.
Rolls’ large installed user base of engines is a massive competitive advantage. As you read this, there are literally thousands of Rolls-Royce engines in the air globally. They all need regular servicing.
Meanwhile, a rigorous focus on cost control in recent years has been helping improve things at the bottom line, while strong demand drives the top line.
That helps explain why the company has repeatedly raised its financial targets in recent years, pushing the Rolls-Royce share price ever higher.
Here’s why I’m out
That could continue. I think the share price could yet go even higher from here.
But the company’s room for error or disappointment is now very small, as such high expectations are reflected in the share price. At 52 times earnings, the Rolls-Royce share price is starting to look dizzyingly expensive to me.
A terrorist attack, war, or pandemic could see civil aviation demand drop dramatically in short order, as has happened repeatedly over the decades. That risk alone means, Rolls-Royce shares are not a good fit for my portfolio at the current price. I will not be buying.
