The Rolls-Royce (LSE:RR.) share price has been on an incredible run in recent years. And even over the last 12 months, the engineering giant’s up another 40.1%.
That means a £1,500 investment a year ago is now worth about £2,101.50. But over the last few weeks the shares have been quite volatile, which raises a lingering question: has Rolls-Royce reached its peak?
Improving fundamentals
Rolls-Royce is a far more focused business than it was a few years ago. And the latest trading update suggests the turnaround’s still moving in the right direction.
Chief executive Tufan Erginbilgiç said the group had had a “strong start to the year” and was continuing to expand the earnings, cash, and growth potential of the business. In other words, the share price isn’t just being driven by strong investor sentiment, there are genuine fundamentals behind it.
Digging deeper into the numbers, Rolls-Royce has reiterated its guidance for the full year, with underlying operating profit expected to land between £4.0bn and £4.2bn alongside delivering free cash flow of £3.6bn-£3.8bn. That’s despite all the disruptions created by the conflict in the Middle East.
The other big support is the balance sheet. Rolls-Royce pointed to a net cash position and a best-in-class total cash cost to gross margin ratio, both of which give it more flexibility than investors used to see from this business.
So if the numbers are looking good, why has the share price seemingly started to wobble?
Can the rally keep going?
Rolls-Royce is currently capitalising on several powerful tailwinds. Civil aerospace should continue to benefit from higher engine flying hours, defence demand remains structurally strong, and power systems are still tied to broader electrification and industrial growth. If management keeps delivering, shareholders could continue to enjoy impressive returns.
However, it’s important to recognise that some of this future growth expectation has already been priced in.
With a forward price-to-earnings ratio of 33.4, Rolls-Royce is no longer the dirt cheap turnaround stock it was back in 2021. And while the improvement in business quality definitely justifies this premium price tag, it nonetheless opens the door to volatility if targets are missed.
So far, management’s proven to be quite skilful at hitting or exceeding its targets. But with significant exposure to the current geopolitical climate and trade route disruptions, the company could see its financial momentum slow, even with perfect execution.
So have we seen the peak?
The bottom line
Betting against Rolls-Royce in the last few years has proven to be a costly mistake. And looking at the business today, I can’t help but be impressed by its operational quality and exceptional cash generation.
Having said that, the macroeconomic environment’s a source of concern. Rolls-Royce and its share price appear vulnerable to disruption through no fault of its own. And it’s why I think we might be near the peak today, at least in the near term.
However, that also means, for long-term investors, a buying opportunity at a much more attractive price could be right around the corner. That’s why I’m already investigating further.
Should you invest £5,000 in Rolls-Royce Plc right now?
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Zaven Boyrazian does not hold any positions in the companies mentioned.
