A 1,384% gain in share price? Yes, please! That sort of gain might sound like the stuff of investor dreams, rather than the performance of a blue-chip share in just five years. But that is what the Rolls-Royce (LSE: RR) share price has achieved.
For some investors, that means an incredible return.
Meanwhile, perhaps many of us will be looking on, wondering how we missed out on such an opportunity!
I think a more productive approach may be to look forward, asking what lessons we can learn from the Rolls share’s remarkable rise as we scan the stock market today for possible future stars.
Look at market size
Five years ago, demand for civil aviation had fallen dramatically. So, a lot of people wrote off the prospects for Rolls-Royce.
From our perspective today, that may seem a bit odd. After all, Rolls also has defence and power generation divisions alongside its large civil aviation business.
Still, a hit to civil aviation demand was critical then – as it would likely still be now, given its size and importance to the company.
But what many investors five years ago seem to have missed was that long-term civil aviation demand was likely to return to its historical norm, sooner or later.
That matters. The industry is large, likely to stay that way over the long run – and has high barriers to entry.
Liquidity is crucial and pays off
Still, investors clearly had their doubts back then. Why?
One explanation is that they feared that Rolls might run out of money before demand recovered enough.
That was not without reason. In 2020, Rolls-Royce had a rights issue where it sold billions of new shares at pennies each to raise cash.
Painful though that may have been in terms of shareholder dilution, I think it was smart. After all, no matter how strong a business’s fundamentals may be, it always needs to have enough cash (or liquidity, at least) to keep going.
That can be in terms of a company’s current liquidity. But when a company is beaten down, it may also be relevant to look at the firm’s ability to boost liquidity.
With its strong brand, installed base of engines, and patented technology, Rolls-Royce was in a strong position to raise more money.
So, when a company is on its knees, one of the questions I ask is not just whether it has enough money to keep going, but also whether I think it has a strong ability to raise cash when it needs to.
Where’s the competitive advantage?
The soaring Rolls-Royce share price has been in part due to management setting and achieving ambitious business goals.
But lots of firms set tough objectives, only to fall short. What has been different about Rolls-Royce?
I think its strong management has helped a lot. But underlying that has been a powerful brand, a customer base built over decades, and engineering prowess.
In other words, Rolls has what I see as genuine competitive advantages. That helps explain why it has not only survived a tough period during the pandemic, but prospered.
From an investing perspective, I always look for a business to have a competitive advantage!
