Image source: Rolls-Royce plc
Almost exactly a year ago, one of my colleagues at The Motley Fool asked: “When will it be Rolls-Royce (LSE: RR.) Share price hit £4?“
It turns out the answer was March 2024. Since then, with a gain of 140% in the last 12 months, Rolls-Royce shares have soared to £5.
So, at 529p at the time of writing, will it reach £6 and when?
No assumptions
First, I must emphasize that I never assume that any stock will reach a specific price. I've been waiting a long time for him Lloyds Banking Group share price reaches £1, for example.
But what we can do is look at the things that might push you toward a specific goal. And then think about the ways the wheels could come off.
And the first bullish thing I can say about Rolls-Royce is that it continues to deliver.
In the first half August update, CEO Tufan Erginbilgic was in his usual mood of unbridled enthusiasm. “Our transformation of Rolls-Royce into a high-performance, competitive, resilient and growing business is progressing with pace and intensity.“, said.
And who doesn't want rhythm and intensity?
Revenues, profits, margins… all are rising strongly. Underlying core earnings per share (EPS) soared 83% (even as statutory EPS fell).
Reasons to be afraid
On the contrary, I worry about what will happen if, after one quarter, Rolls fails to beat analysts' forecasts. Maintaining optimism may require beating forecasts, rather than simply keeping up with them.
I often wonder if growth stock investors follow a mantra that what goes up keeps going up. It seems to be the way analysts set their price targets. Every time a stock price rises, they raise their target a little higher. Is this how they do it?
But if a growth stock keeps going up, it will only be until it stops.
And if my experience over the years is anything to go by, when the bulls decide to move on to the next big thing, the price can drop like a sack of potatoes.
Valuation
But coming back to the bullish side again, I still think Rolls-Royce's valuation looks attractive, even after the price hike.
We're looking at a price-to-earnings (P/E) ratio of 31 for the current year, or about double the long-term ratio. FTSE 100 average. But analysts expect earnings to rise 33% between 2024 and 2026, which would reduce the P/E to 23.5.
And I think that could be sustainable. If Rolls-Royce's next set of results excites the market again, I think we could see £6 in the next 12 months. That price would mean a P/E of 31 by 2025. There is a trading update in November.
Is it cheap?
The problem I have is that I might now consider Rolls stock to be a fair value. But they are not very cheap and I don't really see much margin of safety. So I won't buy because the risk is too high for me.
But if Rolls continues to exceed expectations? This time next year, might we wonder when it will reach £7, £8 or more?