Image source: Rolls-Royce plc
When a share increases in value by 1,491% over five years, many investors are nervous that it may well have peaked already. That is the share price gain recorded by Rolls-Royce (LSE: RR) shares over the past five years.
Currently the FTSE 100 aeronautical engineer’s share price is around 6% below its all-time high, recorded earlier this year. But could it be possible that, rather than peaking at these sorts of levels, Rolls-Royce shares keep moving upwards in years to come?
Some possible growth drivers
I think it is possible. There are potentially multiple reasons why Rolls-Royce shares could move up from here.
At a big picture level, there are the strong trends. Rolls has three core businesses: civil aviation, defence and power systems and all three areas are currently seeing strong positive trends in customer demand.
The first half of this year saw the company achieve organic underlying revenue growth of 29%, 17% and 28% in those three areas respectively.
Part of that growth could come from higher pricing or taking market share from rivals. But the wider implication is clear: Rolls has the wind in its sails in all three areas.
A second possible growth driver is the company’s installed user base. Rolls-Royce has thousands of aircraft engines in operation around the world. Servicing engines over decades can often be far more lucrative than the initial sale.
Applying this ongoing service model in its various business divisions could give Rolls pricing power in years and decades to come. That could potentially help profits to rise faster than revenues.
An additional factor that has helped Rolls-Royce shares is good business management. In recent years the firm has earned a reputation for setting and consistently achieving ambitious financial targets. Investors like and tend to reward this sort of consistently reliable business performance.
Lots to like – but what about the price?
The challenge though, is currently more about valuation than business performance. Currently, the share is priced at 49 times earnings. To me that seems unjustifiably high.
However, if business continues to grow at a strong rate, earnings might soar from here. In the first half, underlying profit before tax rose 48% year-on-year (though on a statutory basis, profit before tax actually fell 60%).
That could mean the prospective price-to-earnings ratio is considerably lower than the 49 I mentioned above.
If Rolls-Royce maintains its high growth rates in coming years, without any disappointments, I do therefore think its share price could potentially move up substantially even from today’s levels.
My concern is that high expectations are already built into the share price.
Over the decades, Rolls and other engine makers have repeatedly been blindsided by sudden large drops in civil aviation demand, for example during the pandemic. That risk remains and I do not think it is properly priced in.
So instead of buying Rolls-Royce shares, I am actively looking for other much more attractively priced growth shares in the market this September.
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Christopher Ruane does not hold any positions in the companies mentioned.
This story originally appeared on Motley Fool
