Some investors who put money into Rolls-Royce (LSE: RR) a few years ago may now be rightly pleased with their investment. The Rolls-Royce share price has been on an incredible tear, moving up 1,362% over the past five years.
Wow!
But after that sort of increase, could there possibly still be any value left when looking at the share today?
I think there could be. However, for now at least I do not plan to invest. Here’s my reasoning.
Solid basis for share price growth
The sort of increase we have seen in the Rolls-Royce share price over recent years sometimes happens with an obscure penny share, or small business that is suddenly transformed.
Five years ago, the Rolls-Royce share price did stand in pennies. But it still had a market capitalization of billions of pounds.
It was a long-established business in a mature industry. Not the usual sort of racy candidate for an explosion in share price of the type we have seen.
But that share price growth was potentially justified, in my view. Five years back, the company was burning cash fast and the outlook for customer demand was both weak and difficult to predict over the medium- to long-term.
Since then, demand has bounced back – and Rolls is also in much better shape as a business.
It is more streamlined, has a stronger balance sheet, has cut costs, and is delivering more consistently on its financial targets than it did at points in its long history.
So, although the Rolls-Royce share price has soared, I actually think that gain may well be justified.
Maybe cheaper than it looks
If the company keeps meeting or surpassing its financial targets – as it has been doing in recent years – I expect earnings per share to grow meaningfully.
Considering that, I do not necessarily think the current Rolls-Royce share price is unjustifiably expensive at 16 times earnings. In fact, if the business continues doing well, I think we could potentially see it move even higher in the coming years.
With its large installed base of engines, powerful brand, proprietary technology, and strong demand not only in civil aviation but also defence and power generation, I think the firm may be in the right place at the right time.
But will that turn out to be the case?
Ongoing possibility for upset
Some of those strengths lie under Rolls’ control. But some of the factors that have helped it do well lately are partly or totally outside its control.
Take demand as an example. When civil aviation demand is high, that is understandably good news for revenues at the company. But such demand has a nasty habit of suddenly collapsing without warning. We saw it in the pandemic and have seen it on other occasions, such as following the 2001 terrorist attacks.
Such demand slumps can wreak havoc on Rolls’ revenues and profitability – but lie largely or wholly outside its control.
Although I like the business, I do not think that risk is reflected in the current Rolls-Royce share price. So, for now, I have no plans to invest.
