It’s not hard to see why the FTSE 100 stock is being snapped up by investors. This year, Rolls-Royce’s share price is down 60% (it was down 85% at one stage). This is attracting value investors.
Should I buy the stock myself? Let’s take a look at the investment case.
Rolls-Royce: can the share price recover?
The reason Rolls-Royce shares have plummeted in 2020 is that the company generates a large proportion of its revenues from the manufacturing and servicing of engines for the commercial aviation industry. Last year, its civil aerospace division generated 52% of total revenues. With Covid-19 devastating the aviation industry this year, Rolls-Royce has been hit hard. This year, analysts expect the group to generate a net loss of £2.6bn.
However, now that a coronavirus vaccine is potentially on the horizon, the outlook is for the aviation industry is improving. When news broke of Pzifer’s vaccine last week, Rolls-Royce’s share price surged.
I think Rolls-Royce shares have the potential to keep rising in the short term. After all, the stock has been well and truly smashed this year.
That said, RR is not a stock I’d buy today.
I wouldn’t buy Rolls-Royce shares
The reason I wouldn’t invest in the firm is that I see it as a ‘low-quality’ stock.
Just look at the company’s recent financials.
This year isn’t the first time in the recent past that Rolls-Royce has generated big losses. It also made huge losses in 2016, 2018, and 2019. That’s a poor track record.
Meanwhile, the company hasn’t lifted its dividend since 2015. By contrast, FTSE 100 businesses such as Unilever and Diageo have lifted their payouts every single year since then.
It’s worth pointing out that on Stockopedia, RR has an Altman Z1 score (this is a measure of financial strength) of -0.2. This indicates that there’s a serious risk of financial distress within two years. Meanwhile, Stockopedia gives the company a ‘quality’ score of 12… out of 100.
All in all, Rolls-Royce has very little quality. This is the kind of stock that Warren Buffett would run a mile from.
Pfizer vaccine: no magic bullet
Another reason I wouldn’t buy Rolls-Royce shares right now is that I suspect the airline industry is likely to struggle for a number of years as a result of Covid-19. A vaccine will help the industry, for sure. But I doubt it will be a magic bullet.
The industry may not return to pre-Covid-19 levels for four or five years. “It would be massively premature to say that the airline sector can now return to normal,” said aviation analyst John Strickland – who has nearly 40 years of experience in the industry – last week.
Better stocks to buy
All things considered, I don’t see a lot of investment appeal in Rolls-Royce shares. The stock could keep rising in the short term. However, its lack of quality puts me off investing.
I think there are better stocks to buy.
Edward Sheldon owns shares in Hargreaves Lansdown, Unilever, and Diageo. The Motley Fool UK has recommended Diageo, Hargreaves Lansdown, and Unilever. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.