Image source: Rolls-Royce plc
It has been an incredible few years for the Rolls-Royce (LSE: RR) share price. Over the past five years, the Rolls-Royce share price has soared 2,927%. That sort of performance would be remarkable for any stock. But it is exceptional for a long-established blue-chip company operating in a mature market.
Having achieved that performance in the past five years, might the aeronautical engineer be able to do it again over the coming five years?
The data baseline matters
There is no denying that the Rolls-Royce share price has been on fire lately in objective terms. It recently hit yet another all-time high.
However, it is important to think subjectively as well as objectively. One reason the share has done so well over a five-year timeframe is because it was in the doldrums five years ago.
The pandemic had sent demand for civil aviation much lower, leading airlines to cancel or postpone aircraft purchases, while engine servicing cycles were stretched.
Rolls-Royce shares sold for pennies in 2020 and yet the company issued billions more at what now seems like a bargain price, because it badly needed to shore up its liquidity.
By contrast, the business now is doing extremely well. It has seen revenues grow, is solidly profitable and foresees improved financial performance over time.
The law of large numbers
The share price rise of recent years means Rolls-Royce now commands a market capitalisation just shy of £100bn. So if the share price was to grow another 2,927% in the coming five years, the market capitalisation would likely be just over £3trn. It may be a bit lower, as Rolls is buying back some of its own shares, but let’s call it a round £3trn.
That is not an impossible market capitalisation for a company: Nvidia has a market-cap of over £3trn at the moment.
But the UK stock market tends to be a sleepier place than New York. Currently the UK firm with the largest market-cap is AstraZeneca, at £193bn (Rolls-Royce comes fifth).
I simply do not think a £3trn market-cap is realistic for any UK firm over the next five years.
Potential for a higher valuation
One counter to that argument is that, if Rolls’ earnings grow quickly enough, its valuation may do the same. That could be true.
Currently, Rolls-Royce’s share price-to-earnings ratio is 17. Underlying operating profit grew 50% year-on-year in the first half. The firm expects to grow that number to £3.6bn-£3.9bn in the medium term. That would represent 46%-54% over last year’s numbers.
If it achieves that goal, I do see a case for a higher Rolls-Royce share price than today.
But high expectations are already baked in and the sort of growth foreseen is nowhere near what it would take to justify a 29-fold growth in share price, as I see it.
Watching, without buying
I like the business. It has unique technology, limited competition and a large installed client base. I also like its growth prospects.
But the current price assumes a lot. We know from past experience that sporadic unexpected slumps in passenger demand can wreak havoc with the economics of engine makers.
Meanwhile, investor expectations now seem so high that any hint of underperformance by Rolls-Royce could see its share price fall, I reckon. I will not be investing.
