It has been quite a stock market ride for Rolls-Royce (LSE: RR) in recent years. Standing in pennies in 2022, the Rolls-Royce share price has come storming back. The aeronautical engineer’s shares have lately been over £4 each and hit £4.35 this month.
The past few days though saw the shares slide. This could be just part of the normal ups and downs of markets. But it may also mark that the City thinks the shares have flown too high, too fast and the price is reacting accordingly.
Incredible rise
Last year, Rolls was the best performing FTSE 100 share. Since then, it has continued to gain altitude at speed, moving up 37% so far this year.
That has been a result of two things. One is an improving business performance, as shown by last year’s results. A £1.1bn post tax loss the prior year turned into a £2.4bn profit this time around.
But the second factor has been Rolls-Royce management setting expectations high when it comes to future performance.
That has excited investors. If Rolls-Royce can meet its medium-term targets, even its recent share price may look like good value. For example, the current market capitalisation of nearly £35bn is around 12-14 times targeted underlying operating profit for 2027.
If the firm can achieve those challenging targets in the medium term, perhaps it can do even better over a longer timespan. On that basis, the current Rolls-Royce share price might yet turn out to be a long-term bargain, even after its stellar rise over the past year or so.
Show me the money
Why, then, have the shares seemed to stall in recent days? It is important to keep things in perspective – a few days of decline does not necessarily indicate a long-term trend.
For now, it is simply too early to know if the Rolls-Royce share price has peaked.
I think some investors will have been taking profits off the table by selling, happily turning the large paper gains of recent months into actual cash ones. That could partly explain the recent price movement.
It could well also be that the shares are pausing for reality to catch up.
The price increase has been significantly boosted by the business potential implied by the medium-term targets. But those remain targets – now the City is waiting to see how well Rolls can actually deliver on them. After all, it has a long history of erratic financial performance, with some stellar years followed by far weaker ones.
On that basis, I think the shares may have peaked for a while, awaiting further proof that the business is on track to deliver. That could come in the form of a trading statement, or at the interim results stage, for example. However, only time will tell.
My take
Although I like the business, I think the current Rolls-Royce share price offers me little margin of safety as an investor.
The business has a large installed customer base, limited competition and unique technology… all strong points.
But a sudden unanticipated event could hurt demand from airline customers overnight, a risk I do not feel is accurately reflected in the current share price.
For that reason, I have no plans to buy.
