To say that Rolls-Royce (LSE: RR) has been on a roll is putting it mildly. Last week saw the Rolls-Royce share price hit a new all-time high – for the umpteenth time so far this year.
When a share behaves like that, it can sometimes signal that it is getting ahead of itself and headed for a crash. But, alternatively, it can signal that a well-performing business has captured investors’ imagination.
I think the Rolls-Royce share price could yet move even higher from here. But I have no plans to buy even a single share in the aeronautical engineer for my portfolio.
This share’s been on fire!
With markets riding high this year, I think Rolls-Royce shares have certainly benefitted from some momentum driven by investors fearful of missing out.
After all, the Rolls-Royce share price has soared 2,064% over the past five years. For a blue-chip share in a mature industry, that is an exceptional performance.
But while some shares that record such price rises are little more than speculative bubbles, that is not how I see Rolls-Royce.
The business is large and profitable. It has a number of competitive advantages, from high barriers to entry in its industry to a large installed base of engines and proprietary technology.
Not only that, but what has really excited many investors in the past couple of years – and helps explain last week’s all-time high – is current management’s vision.
It has set and raised ambitious medium-term financial performance targets. So far, it has consistently met them, inspiring investor confidence and unleashing more excitement about how well the business may do in coming years.
Lots to like about Rolls-Royce
In fact, on that basis, I do not even think the share is necessarily overvalued despite its phenomenal run in recent years.
The current price-to-earnings (P/E) ratio of 17 does not strike me as cheap – but it does not look particularly expensive, either. Looking ahead, the prospective P/E ratio could well be lower, given the company’s financial goals and the likelihood of earnings growth.
Meanwhile, not only is the FTSE 100 firm benefitting from internal growth drivers such as strong management ambition, it also has the wind in its sails thanks to the external market environment.
Spending on defence, civil aviation, and power systems is set to grow in coming years. That is good news for Rolls-Royce as it operates in all three of those areas.
I’m not ready to invest
All of that makes me like the stock. In fact, at the right price I would be happy to buy it.
For now, though, the price is not right (for me, at least). Yes, I think the share could keep moving higher. But what concerns me is the risk of Rolls-Royce disappointing the City with a miss on earnings, potentially sending the share lower.
That could happen in the normal course of business, for example, because of a problematic contract or delayed sale. But I think current management is good enough that that is unlikely in the short term, although always possible in any business.
What management cannot control, however, is the risk of a sudden unexpected event sending civil aviation demand sharply lower overnight. That has happened before – and it is the risk that, at the current share price, puts me off investing.
