Has the Rolls-Royce share price gone crazy?

18/06/2024

Mixed-race female couple enjoying themselves on a walk

The Rolls-Royce Holdings (LSE: RR.) share price has soared beyond my wildest dreams. In late 2022, the shares were down around 70p. As I write, we’re looking at 460p. That’s more than a sixfold rise.

And to think, I feared the company might even go bust during the stock market crash.

More growth

Well, that’s it, a nice recovery and we’ll see something steady from here… that’s what I thought going into 2024.

Wrong! This year alone, the price has climbed more than 50%. That’s a cracking run on its own, even without the big climb that came before it.

Have things really gone crazy? Part of me thinks yes. It’s not the first time I’ve seen investors pile into a growth stock and push it way up. I’ve seen it lots of times.

What can then happen is like a game of chicken. Everyone hangs on as long as they can until it all comes crashing down.

Strong outlook

But I’ve also looked at forecasts and valuations. And that makes part of me think Rolls-Royce shares might still be a good long-term buy. And maybe the market hasn’t lost its marbles after all.

Forecasts put the price-to-earnings (P/E) ratio as high as 32 for the current year. But analysts see earnings rising fast, to pull the P/E down to 23 by 2026.

That’s still way above, say, the P/E of 6.5 at Barclays. But 23’s by no means outrageous for a growth stock.

I know it’s not quite in the same league, but Tesla is on a P/E of 81.

Company optimism

The Rolls board seems to be full of good cheer too. With May’s update, CEO Tufan Erginbilgiç brimmed with enthusiasm. He spoke of “a high-performing, competitive, resilient and growing business,” of growth, contractual improvements, improved margins, efficiencies, value…

And he thinks the firm “will continue to drive growth and create value for all our stakeholders in the mid-term and beyond.”

Now, when I see that kind of bullish mood in a CEO, I like it. But I also hear alarm bells.

Optimism vs risk

The problem is, it can sometimes push the optimism a bit too far. It can set up lofty expectations. And if every one of them is met, then all might be just fine.

But if just one target, one hope, fails to be met, even by only a little, that can prick the bubble. And it can be hard to get people back on board after a short-term slump.

And that’s another thing I’ve seen more often than I’d like. I’ve seen good long-term growth stocks slammed due to a short-term disappointment, when it’s just not deserved.

Verdict

My verdict? If Rolls-Royce can live up to the level of optimism I see built into its share price, we could see sustainable rewards.

But if it should fall short by even a tiny margin, well… that might mean better buy prices ahead. And I’ll probably miss them. Just like I missed all the past ones.

Passive income stocks: our picks

Do you like the idea of dividend income?

The prospect of investing in a company just once, then sitting back and watching as it potentially pays a dividend out over and over?

If you’re excited by the thought of regular passive income payments, as well as the potential for significant growth on your initial investment…

Then we think you’ll want to see this report inside Motley Fool Share Advisor — ‘5 Essential Stocks For Passive Income Seekers’.

What’s more, today we’re giving away one of these stock picks, absolutely free!

Get your free passive income stock pick