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As with any stock, the Rolls-Royce (LSE: RR) share price can go down as well as up. I thought that old truth is worth stating, as lately it’s only gone in one direction – like a stratosphere-bound rocket. Can it last?
Rolls-Royce shares are up 1,200% over the last five years, turning £10,000 into a spectacular £130,000 and potentially transforming people’s retirements all on its own. I’d have expected its momentum to flag by now, but it’s up 110% over the last 12 months. It still managed to climb 7% in the last month.
But surely this is as good as it gets? The stock trades on a towering price-to-earnings ratio of 61, streets ahead of the FTSE 100 average of around 18. That’s an awful lot of future growth priced in and, if profits disappoint, the shares could tumble as investors bank gains and short-term bandwagon jumpers cut and run.
FTSE 100 growth monster
I don’t know if that will happen, but any investor who holds this stock, or is thinking of buying it, must accept that’s a risk.
At The Motley Fool, we encourage long-term investing. As a rule, we aim to hold shares for years. We think second-guessing short-term movements is nearly impossible. Try to get clever, and the market punishes you. The real benefits of investing are measured in decades, not weeks. This gives companies time to grow, and allows reinvested dividends to compound. Buying and holding also saves on trading fees. They add up.
So my natural bias is to hold Rolls-Royce whatever the news flow brings. Even though I believe the shares must slow from here, and might even crash.
As with every stock, there are risks. Rolls-Royce relies on a complex global supply chain for aerospace engines and components. Delays, shortages of critical parts, or problems at key suppliers could hurt production and revenue. Technical or operational failures are a risk, as we’ve seen with its troubled Trent 1000 engines. Any slowdown in passenger air travel could also hit sales and engine maintenance income.
Risks and rewards
Its Power Systems arm is benefiting from the rush to build artificial intelligence (AI) data centres, but if AI is a bubble, that could end. Peace in Ukraine, in the unlikely (so far) event it happens, could hit the defence arm, while the huge opportunity in small modular reactors or nuclear projects may never materialise. All of these could hit Rolls-Royce.
The biggest short-term risk lands on 26 February, when Rolls-Royce delivers full-year 2025 results. It anticipates underlying operating profit between £3.1bn and £3.2bn, and free cash flow ranging £3bn and £3.1bn. Any shortfall could be punished hard. On the other hand, if the company exceeds targets, and given CEO Tufan Erginbilgiç’s stellar track record it certainly could, the stock could climb another leg higher.
Although the trailing P/E looks extreme, the forward P/E is 20.7, which is less daunting. Is it worth considering today? With a short-term view, I’d say no. The quick profits have been made. But in the long run, I’d say yes. This is a brilliant company with a lot to offer. I hold Rolls-Royce and have no plans to sell. But it might still crash.
