It has already been an incredible few years for Rolls-Royce (LSE: RR) shares. Over five years, the share price is up 1,336% — including 21% so far this year.
That means that Rolls-Royce shares now trade for around £14.50 apiece.
Could the momentum keep going towards £20 price, and should I therefore invest? Or is it more likely that the share price is headed down, towards £10?
Right place, right time
The stunning rise of recent years may sound incredible but in fact Rolls has benefitted from its focus on three key business areas, all of which have seen demand increase.
First is civil aviation. After the difficult years of the pandemic, passenger demand for flying came roaring back. With it came demand from airlines for new aircraft engines and the servicing of existing ones.
Higher spending in Europe and elsewhere on defence since Russia’s full invasion of Ukraine has helped boost demand for defence manufacturers including Rolls.
The company’s power systems division has also seen growing interest, and its small modular reactors offer further room for growth in years to come.
On top of being exposed to demand growth in its key areas of business, Rolls has also helped itself in recent years by streamlining. It has become more strategically focussed and cut costs.
The company has set ambitious financial goals and consistently delivered on them, bolstering its credibility with investors.
Going up?
At the moment, the price-to-earnings (P/E) ratio is 51 (using underlying earnings).
That looks steep to me, so at first blush a further advance by Rolls-Royce shares to £20 may seem like wishful thinking.
That price is about 38% above the current share price. Given the 21% growth in the price already seen this year, though, I reckon 38% does not seem outlandish.
Momentum is strong, as it has been for multiple years.
Plus, if the company delivers on its financial targets at the same time as reducing its share count through buybacks, the prospective P/E ratio is lower than 51.
Or going down?
But what if it does not deliver?
For now there is no specific reason to expect that. The company has maintained resolutely upbeat about its business outlook, even though the Middle Eastern war threatened to push civil aviation demand lower, potentially leading airlines to reassess their spending plans.
But history has shown, most recently during the pandemic, that sudden demand shocks can affect the civil aviation industry with knock-on impacts for aerospace engineers like Rolls. That remains the case.
More generally, I think a P/E ratio of 51 for a mature industrial company is high, even one benefitting from buoyant customer demand.
So on one hand I can see a case for Rolls-Royce shares to hit £20. But for a valuation based on business fundamentals, £10 (still 34 times earnings) looks far more justifiable to me.
At the current share price, I have no plans to invest.
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.
