What a month it has been for shareholders in Rolls-Royce (LSE: RR) – yet again! For the umpteenth time this year, Rolls-Royce shares broke new territory, with the price hitting yet another all-time high.
The share price is up a phenomenal 1,200% over the past five years. Even more stunningly, the growth has been 2,660% since an October 2020 low. Wow!
September will see Rolls-Royce paying its interim dividend to qualifying shareholders.
Can its share price maintain upwards thrust this autumn – and beyond? For it to do so, I think a few things probably need to happen.
Rising tides lift all boats
It is no coincidence, I reckon, that both Rolls-Royce shares and the FTSE 100 have hit new all-time highs this month.
A buoyant market does not help all shares, but it boosts investor confidence and helps support many share prices. I think a strong UK stock market is necessary if Rolls is to maintain its recent momentum.
By contrast, a sudden stock market correction or crash could hurt the price of many well-known shares, even if their business fundamentals are strong.
With its price-to-earnings ratio of 52, I see Rolls as liable to suffer if the market tumbles. However, nobody knows how far away that might yet be.
Zero space for disappointment
Under its current management, Rolls-Royce has set aggressive performance targets, hit them (sometimes well ahead of schedule), and then raised them.
Investors have lapped this up – and it is not difficult to understand why.
But it creates an expectation of superb performance and, arguably, no disappointments or misses. Rolls-Royce shares have hit their current level partly due to investors believing that management will deliver on what they have promised.
If there is even a sliver of doubt cast on that, for example, because of some small underperformance on one key financial metric, I think the shares could recoil. As I see it, Rolls has to deliver perfectly to justify its current share price premium.
Resilient end market demand
What concerns me more than that, though, is the potential cause of any such possible future disappointment.
Management can control many things. But some things lie totally outside its circle of influence.
In the civil aviation division, a sudden downturn in passenger demand could see airlines delay engine maintenance and new engine purchases. Such downturns have happened sporadically over the decades: the pandemic was the most recent one.
The defence business looks more resilient for now, with European governments collectively boosting their spending on military kit significantly.
Power systems includes some fairly new product lines for Rolls, notably when it comes to small modular nuclear reactors.
In the long term, that could be a big growth driver for the business. Closer in, though, there is the risk as with any groundbreaking project of time or cost overruns for reasons outside Rolls’ control, from planning restrictions to government policy delays.
I’m avoiding the share for now
Those risks mean that, at the current price, I will not be buying any Rolls-Royce shares for my portfolio.
If none of the risks above eventuates and business keeps going well, I believe the share price could potentially move up in September and beyond.
But the risk profile, relative to the share price, puts me off buying for now.
