Image source: Rolls-Royce plc
It was another knockout month for aerospace engineering shareholders Rolls Royce (LSE:RR). Shares of Rolls-Royce hit a new high and are now up about 83% so far in 2024 after hitting an all-time high. FTSE 100 index had the best performance last year.
This means that the shares have risen in price by 120% in five years.
I don’t currently own them and missed the last wave.
Given the momentum we’ve seen lately, should I add them to my portfolio as we head into November?
The enthusiasm among investors continues
Some investors make choices based solely on momentum. But in the stock market, as elsewhere, it’s not like they’re going to keep doing that just because things have gone up.
Although the company has improved its performance in recent years, I believe that much of the rapid rise in the price of Rolls-Royce shares reflects investor enthusiasm.
That could be dangerous because if it shifts (something that can happen overnight), it could mean the stock loses some of its support, potentially leading to a price drop.
The business community is doing well and can do even better
From a sales perspective, the company is doing well. Halfway through the year, turnover was 18% higher than in the same period last year.
That means revenues are now on track to exceed pre-pandemic levels, which have meant a very challenging few years for the company.
Created with TradingView
At the bottom line However, pre-tax profits fell slightly in the first half. Basic earnings per share fell slightly more to 13.7p for the period under review, compared to 14.7p for the same period last year.
Basic earnings per share have been volatile in recent years.
Created with TradingView
The company has set ambitious goals, but focuses more on the operating result. These can be very different from profit after tax and basic earnings per share, due to non-operating costs such as interest.
This is why I don’t buy
Also from a valuation perspective, many investors use a price-earnings ratio (P/E). taking into account earnings per share.
Right now, Rolls-Royce shares are trading at a price-to-earnings ratio of around 20. I consider that fully priced.
Valuations walk a fine line between current performance (which is knowable) and future performance (which is not known, but can be estimated). I believe that the price appreciation of Rolls-Royce shares reflects current business performance, but also a large part of the expected value due to future performance.
The company has the wind in its sails. It benefits from an installed customer base, strong demand, a well-known brand, high barriers to entry into the market and also technical expertise. But expectations about future performance, particularly whether Rolls can meet its ambitious mid-term targets, are just expectations for now.
At the current share price, I think there is little room for error should the company see sales decline due to circumstances beyond its control, such as a pandemic. So I won’t be buying this November.