Image source: Rolls-Royce Holdings plc
At multiple points in the past few years, investing in Rolls-Royce (LSE: RR) was an outstanding bargain, seen from today’s perspective. The Rolls-Royce share price is now north of £8, so could it still potentially be a bargain for my portfolio?
Back in 2022, it sold for pennies – a price that now looks like a screaming bargain!
In 2023, it was the best performing of any FTSE 100 share. Yet, for most of the year, the Rolls-Royce share price was below £2. What a deal!
Having done so well in 2023, it might stand to reason that the share was not such a bargain in 2024. In fact, it was one of the best-performing FTSE 100 shares last year. But even since September, it has risen 75% — and shareholders have had the additional good news that the dividend would be reinstated. Again, a massive bargain!
What about this year, so far? The Rolls-Royce share price has risen 38% since the turn of the year. Wow!
The valuation looks high to me
Normally when deciding whether to buy a share, I first consider its business and commercial prospects and only if I like them do I then get into the nitty gritty of valuation.
Here, though, we can go straight to valuation. The current Rolls-Royce share price-to-earnings ratio of 27 immediately raises my hackles as an investor.
This is not some sparkly new startup with a transformational business model. It is a firm established five years after Queen Victoria died, operating in a selection of mature industries and with a long history of chequered financial performance due to the long development timeframes and high costs that are still a structural part of the aircraft engine industry.
Could there be hidden value here?
So, from the valuation alone, I am already sceptical.
Going back to the business, am I missing something that could potentially justify the current Rolls-Royce share price – and perhaps a higher one in future?
A lot of the improvement has been driven by industry-wide positive news, elevated by a highly focused and ambitious management at Rolls. The company has already reached some of its ambitious targets several years ahead of schedule.
It has set more ambitious medium-term targets and continues to benefit from a helpful selling environment, with civil aviation demand robust, defence spending growing strongly, and renewed attention being paid to power systems.
As an engine maker, Rolls knows all about tailwinds – and it looks like it has been in the right place at the right time. I reckon the share could be a bargain even now if everything keeps going as well as it has been lately.
I’m not comfortable with the risks
Equally, though, Rolls understands headwinds – and I see some that could hurt its performance.
Civil aviation demand is already showing signs of weakening in some key markets. An economic downturn could exacerbate that, posing a risk to sales volumes and profit margins.
Meanwhile, civil aviation as always remains exposed to the risk of a sudden demand downturn that comes almost from nowhere, whether due to a terrorist event, war, weather event, or recession.
I think the current Rolls-Royce share price offers me insufficient margin of safety to mitigate such risks, so I will not be investing.
