Image source: Rolls-Royce plc
As recently as 2022, shares in Rolls-Royce (LSE: RR) still sold for pennies apiece. That seems a long time ago already, with Rolls-Royce shares edging towards £10 each recently.
If the positive momentum we have seen in the shares continue, I would not be surprised to see the share breach that price level before too long.
Should that happen, it could provide a boost that helps push the share up even further. On the other hand, it might also lead some investors to question whether the share is really worth so much more than it was selling for just a few years ago.
So, as Rolls-Royce shares push upwards, might it still be worth me buying some for my portfolio?
Ongoing strong business potential
The remarkable price recovery of the share in recent years reflects a turnaround in several key areas.
Externally, demand for civil aviation that slumped during the pandemic later came roaring back. That was a boon for demand for engine sales and servicing.
On top of that, Rolls-Royce’s defence division has benefitted from beefier budgets across Europe, while its power systems business is benefitting from ongoing demand for new power generation equipment.
Internally, the past couple of years have seen the company’s management initiate an ambitious set of medium-term goals.
But while the company is doing well, not everything lies inside its control. One thing that has tripped it up repeatedly in the past – including during the pandemic – is the susceptibility of air travel demand to external shocks such as terrorist attacks and economic downturns. That remains a key risk to future civil aviation demand, as far as I am concerned.
The share could go higher
In fact, that risk alone puts me off buying Rolls-Royce shares at the current price.
If there was a sufficient margin of safety built into the share price then I would be comfortable investing. But, selling on 33 times earnings, the share already looks pricey to me.
Does not mean I think it cannot go to £10 – and beyond? No.
Clearly, Rolls-Royce shares have benefited from strong momentum. That could continue. If the business keeps doing as well as it has been doing, earnings per share could grow. So the prospective valuation may be more attractive than it seems.
But that is not guaranteed to happen. A variety of risks stand in the way. For example, if pushing up profitability means not just more cost efficiencies but also higher selling prices, Rolls-Royce may be less competitive when bidding for work against rival firms.
Meanwhile, although there is more to the firm than civil aviation, that does remain central to how Rolls-Royce performs overall, as we saw during the pandemic. At a price-to-earnings ratio of 33, I do not think the risk of a future sudden aviation demand drop is properly reflected in the price.
So, although I can see why Rolls-Royce shares may go even higher from here, I will not be investing.
