Step aside Rolls-Royce (LSE: RR)? For several years, Rolls-Royce shares were the exciting growth story many stock market investors wanted to talk about. But lately the enthusiasm has been less vocal. Some investors have been more interested in what is going on Stateside, with growth stocks such as Space Exploration Technologies, known better as SpaceX.
But has the growth story at Britain’s well-known aeronautical engineer weakened? No!
Another new record
Take this month, for example. Rolls-Royce shares hit a new all-time high.
For the past several years they have been among the strongest performer on the FTSE 100. This year started with some turbulence but so far, the Rolls-Royce share price is up around 17%. That compares to a 5% gain so far for the index overall.
The year has brought challenges, such as the potential for the Middle Eastern conflict to damage demand for civil aviation. We saw during the pandemic what a threat that can be for Rolls, as airlines may order fewer new engines and reduce servicing frequency on existing ones if they are used less.
But Rolls has taken that risk in its stride. It remains confident that its cost control and business strategy will allow it to absorb any negative impact without hurting its projected business performance for the year.
That partly explains why Rolls-Royce shares have been riding high. But that also reflects investor optimism about business growth opportunities, boosted by recent reports that the company’s power systems division could supply small modular reactors to a project in Sweden.
Could we see more record highs ahead?
After the incredible surge in Rolls-Royce shares – 1,203% in the past five years – it may seem like there cannot be much more opportunity for further strong growth.
But I think there could be. The Rolls-Royce of today is built on the foundations of the Rolls-Royce five years ago. However, it has a more focused strategy, tighter cost control and much more investor support.
It is also benefitting from the prospect of years of demand growth not only for power systems, but also for the company’s defence division. Meanwhile, the civil aviation business is doing well.
That could further boost investor sentiment. If Rolls can deliver on its ambitious medium-term plans to improve financial performance, I think that could also provide another boost.
Current management has consistently proven it can deliver on the expectations it sets.
Here’s my concern
Still, while I am excited about the prospects for the business, what I am far less enthusiastic about it is the FTSE 100 firm’s valuation. Rolls-Royce shares sell for 47 times earnings. Even allowing for the prospect of earnings growth in coming years – which is not guaranteed to happen – that is too steep for my tastes.
Civil aviation remains core to the company’s performance. I see the risk of a demand shock in civil aviation as significant. Ongoing geopolitical conflicts and volatile jet fuel prices mean that risk is real. I do not feel it is properly reflected in the current share price.
So I am looking elsewhere for what I think are today’s strong growth opportunities at an attractive price.
Should you invest £5,000 in Rolls-Royce Plc right now?
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Christopher Ruane does not hold any positions in the companies mentioned.
