I’ve been following the Rolls-Royce (LSE:RR) share price for a while now. Even though the company seems to be making some critical internal shifts to boost efficiencies, I think the stock is overvalued.
I’m taking Warren Buffett‘s advice and “being fearful when others are greedy”.
It’s common knowledge in investing that when share prices surge, there’s only so far they can usually climb above what the financials say a business is worth before the price returns to somme sort of reality.
2023 progress, 2024 outlook
The shares soared by around 200% in 2023, driven by a recovery in air travel, an increase in defence spending and a new CEO with a powerful turnaround strategy.
Last year, measured against the Stoxx Europe 600 index, Rolls-Royce was positioned as the top-performing large-cap company in Europe!
However, there are concerns for 2024. Some analysts are expecting the travel market to dip as the post-pandemic surge potentially wanes.
Furthermore, rising energy bills and household costs are leading to reduced discretionary spending. That could impact how much airlines shell out on new aircraft from Rolls-Royce.
A troubled valuation?
With the current share price so high, I have to wonder if this can continue. I understand the company is making significant internal changes, but the financials don’t look compelling enough to justify the price.
It’s good news the group’s revenues have grown by 32% over the last year. However, because its financials suffered during Covid-19, I think the recent high growth rates are due to the recovery and so can’t be expected to carry on.
Instead, I think year-on-year revenue growth of around 8% might be feasible as a next-10-year average. That’s in line with consensus estimates.
Also, I’ve got to bear in mind I’m looking at a balance sheet with negative total equity. It’s been that way and getting worse since 2018. To me, that’s a clear pointer to trouble ahead for the share price.
Where I see it going next
I think the Rolls-Royce price may keep on rising for a while longer. However, once the earnings growth rates start declining, the share price could as well, especially if the company reports earnings per share lower than in previous quarters.
Therefore, I think it’s inevitable that there will be some volatility in the investment over the next few years. In addition, I’m expecting slower share price growth long term once the current recovery period has stabilised.
As the industries Rolls-Royce operates in are cyclical, the firm’s performance will likely rise and fall with wider economic trends. A continued increase in global defence spending, for example, could indeed mean strong growth for the shares.
I’d opt to hold this one
The company is making impressive changes and has potential opportunities in economic trends at the moment. Therefore, it might be worth holding this one out if I owned it already.
However, it’s not in my portfolio, and at the current valuation, I can’t see a good reason to buy it.
In fact, I think the price might fall soon. With this in mind, its growth rates don’t seem like they’ll be that magnificent long term.
