It has been a phenomenal few years for shareholders in Rolls-Royce (LSE: RR). Back in 2022, Rolls-Royce shares were still selling for pennies apiece. The share price is now north of £11.
Undoubtedly, Rolls-Royce has been one of the most compelling FTSE 100 investment stories of recent years. But what might the coming years hold?
Slowing momentum?
Rolls-Royce shares have been on a fairly consistent upwards march over the past few years. But there have been a couple of bumps.
One was a sharp reversal this spring, when concerns about the potential impacts of US tariff policy kicked in. However, while Rolls-Royce shares fell 18% in barely a fortnight around the end of March and beginning of April, they soon bounced back – and then kept on rising.
The past month has also seen a fall, albeit on a smaller scale. The share price is now around 6% lower than at its all-time high last month.
That might not sound like a big drop. But it could be suggestive that the momentum that has helped drive Rolls-Royce shares upwards is slowing. It may even have started to turn around.
Not necessarily expensive
Trading on a price-to-earnings (P/E) ratio of 17, Rolls-Royce shares are not obviously cheap but they are not clearly overpriced in my view, either.
On top of that, I see a couple of things to like even at the current price.
One is that the company expects earnings to grow, suggesting that the prospective P/E ratio is lower than 17.
Another is the company’s habit over the past several years of not only meeting but surpassing investor expectations. If it can do that again, it could be a fillip for the share price.
No room for error
So, although the recent movement has not been encouraging, I am not convinced Rolls-Royce shares have necessarily run out of momentum yet. Time will tell.
However, there is a caveat. I see the current valuation as presuming that the company delivers. If it fails to maintain its strong performance, I expect Rolls-Royce shares to be hammered.
When it comes to internal factors, I think the company can keep doing well. It has kept a lid on costs and seems to be running smoothly.
I’m sitting out for now
The risk I see is from external factors the firm cannot control. The price wobble in the spring about tariffs showed how such factors can potentially hurt the share price.
Nor do I see the shares as necessarily overpriced. In fact, I think there is a credible argument that if the firm’s financial performance delivers on its goals (or better), today’s share price could even offer long-term value.
Tariff disputes and geopolitical tensions remain a risk to profitability. My bigger concern, though, is about any unexpected fall in customer demand.
In the civil aviation business, demand has sporadically experienced sudden unforeseen slumps. The pandemic is just one example: terrorist attacks and recessions are others.
Such a slump can be disastrous for engine sales and servicing demand, eating badly into Rolls-Royce’s revenues and posing a big risk to profitability.
I do not think Rolls-Royce shares are currently pricing in that risk fully, so I will not be investing.
