Image source: Rolls-Royce plc
Over the past several years, one of the more notable opportunity costs in my portfolio has been selling my shares in Rolls-Royce (LSE: RR) when the price still had a long way to run, in the right direction.
Of course, no-one knew then just how impressive a performance shares in the aeronautical engineer would put in.
In fact, over the past several years, the performance of the Rolls-Royce share price has been little short of phenomenal. Over the past five years, it has moved up by 517%.
So, should I add the share back into my portfolio today? Here are three factors I could see helping to boost the share price.
Strong investor momentum
A gain of 517% happens sometimes for a small growth stock. But for a large, mature company in a mature industry, it is highly unusual.
Clearly, investors have liked the investment case for Rolls and a recent upgrade to its commercial targets has not hurt at all.
I think that sort of enthusiasm could mean plenty of buyers in the stock market and help keep the Rolls-Royce share price moving up.
As an investor, however, I like to invest in businesses because I think they are undervalued relative to their commercial prospects, not because I expect other people to be buying in. So, although I think investor momentum could potentially help push up the Rolls-Royce share price, that does not encourage me to invest.
Solid customer demand
After some very tough years, customer demand in the civil aviation sector bounced back and helped Rolls perform well over the past several years.
I think that could continue, potentially meaning that demand stays elevated both for the sale of new engines and the servicing of existing ones.
That said, several US airlines have recently reported a softening in domestic customer demand. If that trend turns out to be a wider one, it could be bad for demand.
Rolls is not just about civil aviation, though, important as it is for the firm. It also has a large defence business. As European governments continue to ratchet up spending on defence, I think that could be good news for the firm’s revenues and profits in the defence sector.
More efficient business
But there is only so far the business can grow in any given year.
That helps what is known as the top line: how much money the business achieves in sales. What also matters, though, is what is called the bottom line. That is basically the company’s profits.
The Rolls-Royce share price has risen partly because the company has set itself aggressive goals for improving its bottom line business through an efficiency drive.
If that works, earnings could rise, potentially justifying a higher valuation.
Not for me right now
Still, the business already trades for 26 times earnings.
That looks expensive to me based on current performance. I fear that it does not offer me sufficient margin of error if the company encounters some unexpected turbulence.
We saw during the pandemic how civil aviation demand can suddenly drop dramatically for reasons beyond Rolls’ control. I see that as an ongoing risk and so have no plans to invest.
