Image source: Rolls-Royce plc
It’s Tuesday (9 July) and as I write, the Rolls-Royce (LSE: RR.) share price is £4.61. One 12-month target price for the stock has it rising as high as £6. That’s a 30.2% premium.
After its impressive performance over the last few years, that doesn’t seem too ambitious. The stock is up 54.46% this year. In the last 12 months, it’s up 211.9%.
It has been one of the best-performing stocks in Europe in the last 18 months or so. Rolls flirted with bankruptcy in 2020 so it has come some way since that point.
But could it rise by 30% in the next year? That’s what I’m here to answer.
Momentum on its side
There are a few factors I plan to explore to get to the bottom of that. The first is the momentum the stock has.
I want to make it clear that I’d never buy shares of a company solely because they’re rising. But I can understand why the stock has been gaining the amount of ground it has in recent times. There’s a lot to like about the business.
As I mentioned above, it has produced a wicked turnaround from its struggles. In the opening months of this year, engine flying hours returned to pre-pandemic levels. They could even surpass them in the coming months. On top of that, Rolls has boosted its profits, increased free cash flow, and reduced its debt.
As such, it’s targeting up to £2.8bn in operating profit by 2027. Considering that, I can see why investors are hyped about Rolls.
Valuation
But I think there’s one major stumbling block. That’s the stock’s valuation. It currently has a price-to-earnings (P/E) ratio of 16.1. That’s not bad. However, as the chart shows below, its forward P/E is just above 31.
That looks expensive to me, and signals Rolls may be overvalued. It’s also a lot pricier than its rival BAE Systems, which has a P/E of nearly 17.8.
Created with TradingView
The same is seen when looking at its price-to-sales (P/S) ratio. As the chart below highlights, it has been rising in the last year. It’s current P/S of nearly 2.4 is also higher than BAE Systems’ at around 1.7.
Created with TradingView
With that in mind, is there the risk that investors have carried the stock too far? I reckon so. Buying shares for a quick payday doesn’t align with my strategy. I want to build stable wealth over the long run.
A massive leap?
No one truly knows what Rolls stock will do over the next 12 months. But if I had to guess, I don’t think it will rise 30%.
In fact, given its meaty valuation, I reckon we could even see its share price pull back.
After skyrocketing, it was inevitable that the stock would slow down. We’ve seen small signs of this lately. For example, the Rolls share price has barely budged in the last month, falling by less than 1%.
While its future aims are ambitious, at the first sign of slower growth from the firm I think we could see its share price recoil. If that happens, that’s when I’ll be looking to add it to my portfolio.
