2023 was a great year for Rolls-Royce (LSE:RR). And 2024? The same again. As for 2025, another great performance so far, with Rolls-Royce shares recently hitting an all-time high.
The share price has moved up 97% so far this year, on top of its strong gains in the two prior years.
For many Rolls-Royce shareholders, that may be thrilling. However, is the price still grounded in reality?
Stock markets look forward more than back
Historical data is used a lot by investors. My mention above of an all-time-high Rolls-Royce share price was an example.
But what matters when it comes to generating investment returns is how a business will do in future.
Of course, nobody knows this for sure, so in any forward-looking financial assessment there is always some level of guesswork.
In recent years, Rolls-Royce’s business has been doing much better than before. But what I think has really been driving the surging Rolls-Royce share price is an expectation that its future business performance can be substantially better than its current one.
Proven business with lots to like
That, of course, is an expectation that various investors have about many companies.
When it comes to Rolls though, I see grounds for such optimism.
In recent years, management has set a series of ambitious financial goals. Not only has it proven adept at meeting them, but it has revised goals upwards on multiple occasions.
Such performance is catnip for the City, of course. Over time I think it will get harder to keep beating expectations, as the easy wins like cost-cutting will already be factored into performance. But I do think Rolls ought to be able to improve its performance in line with its goals over the medium term. If things go really well, it may surpass its goals.
The FTSE 100 firm is benefitting from high demand in civil aviation and defence. Meanwhile, its power generation business is also benefitting from strong demand – and could be helped in years to come by the rollout of the company’s small modular nuclear reaction programme.
Here’s why I’m not investing
Looked at like that, I do not think Rolls-Royce shares seem detached from economic reality.
Their price (17 times earnings) reflects the company’s strengths, its impressive recent performance, buoyant end markets and an expectation of more strong performance in future. That helps explain why it hit a new all-time high.
However, not all of those things are guaranteed to last.
Civil aviation demand has been strong in recent years. But tightening household budgets and a lacklustre economy could mean weaker bookings for airlines in the next few years. That is a risk for revenues and profits at Rolls-Royce.
I also think that, priced as they are, Rolls-Royce shares do not offer me a margin of safety for a sudden, unforeseen event that quickly sinks civil aviation demand. We have seen that many times before, including the pandemic, volcanic ash clouds and terrorism events.
So I will not be adding the stock to my portfolio at the current price.
