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At 305p, should I ‘snog, marry, or avoid’ Rolls-Royce shares?

Image source: Rolls-Royce Holdings plc
Image source: Rolls-Royce Holdings plc

Rolls-Royce (LSE:RR.) shares are currently changing hands for more than three times what they were at the start of 2023. But despite this impressive performance, the share price is at the same level it was five years ago.

Have I left it too late to get a piece of the action?

Snog

Regardless of the company involved, investing for the short term is — in my view — never a good idea. In fact, holding shares for a few days (or hours) is trading, rather than investing.

Share prices can be highly volatile over short periods.

Perhaps the most successful investor of all time, Warren Buffett, once said: “Our favourite holding period is forever.”

Marry

The arguments for tucking away Rolls-Royce shares in my Stocks and Shares ISA — and forgetting about them until I retire — are compelling.

However, at this time, I’m not persuaded this is the right course of action.

The company has undoubtedly bounced back well from the pandemic. It upgraded its earnings forecast twice in 2023, which helped it become the FTSE 100‘s best performer.

Flying hours — the single biggest contributor to the group’s revenue — are approximately 85% of where they were before Covid arrived.

Encouragingly, the company reported in August 2023 that its large engine order book had increased for the first time since 2018. Its Civil Aerospace business has now received forward customer commitments equivalent to approximately eight years’ revenue.

The company’s Defence division is also performing well. The UK and US governments are big customers, and have pledged to spend more on security.

Across the business, it’s embarked on a cost-cutting programme intended to save £200m a year. And the directors are planning to dispose of non-core assets.

All this means the company’s profitable once more.

Plus net debt is falling.

Avoid

But despite these good reasons to invest, I feel the shares are expensive.

The consensus forecast of analysts is for earnings per share (EPS) to be 12.9p, for the year ending 31 December 2024.

If correct, it means the shares are currently valued at 24 times’ earnings.

Looking further ahead, the expectation is for EPS of 16.5p, in 2025. This is a multiple of 18, which is still not cheap.

Of course, analysts may be wrong. But their forecasts would have to be wildly inaccurate for the company to have a price-to-earnings ratio close to that of the FTSE 100, of approximately 11.

Quality companies rightly command a premium — Rolls-Royce has a great brand and strong reputation.

But I suspect much of the expectations of improved profitability have already been factored into the share price.

Also, the company doesn’t pay a dividend.

Although it’s expected to be reinstated soon, even the most optimistic are forecasting a payout well below the FTSE 100 average.

That doesn’t appeal to an income investor like me.

For better for worse, for richer for poorer

For these reasons, I’m going to keep the stock on my watch list.

And revisit the investment case should there be a correction in the share price.

Before committing to marriage, I want to make sure I’ve made the right decision. Otherwise, a painful (and expensive) divorce could be on the cards.

The post At 305p, should I ‘snog, marry, or avoid’ Rolls-Royce shares? appeared first on The Motley Fool UK.

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James Beard has no position in any of the shares mentioned. The Motley Fool UK has recommended Rolls-Royce Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Motley Fool UK 2024