The Rolls-Royce (LSE: RR) share price has jumped about a fair bit over the past 24 months. In May 2019, the stock was changing hands for just over 300p. However, it steadily declined throughout the rest of the year. By the beginning of 2020, the price of a share in Rolls had fallen to 232p.
Then the coronavirus pandemic began. Rolls was disproportionately affected as the crisis brought the global aviation industry to its knees. The stock plunged below 100p in April 2020 and fell to a low of 39p in October.
Since then, investor sentiment has steadily recovered. The Rolls-Royce share price returned to 130p in December 2020 as it looked as if the world was beginning to move on from the pandemic.
Then the second wave struck. While the stock never returned to the low of October 2020, it dropped significantly, falling around 40% from the beginning of December to the end of January 2021.
Trying to value the Rolls-Royce share price
I think this volatility shows just how hard it has been for the market to understand how much Rolls is worth right now. The company is battling numerous headwinds, and its outlook is far from clear. So trying to value the business at this point is incredibly difficult.
That being said, while past performance should never be used as a guide to future potential, we can look at the company’s historical revenues and profits to try and estimate how much the stock could be worth in the best-case scenario.
In 2019, the group’s revenues totalled £16.6bn. Throughout much of that year, the company’s market capitalisation was around £18bn. That suggests a market capitalisation-to-sales ratio of 1.1.
This gives me some guidance as to how much the Rolls-Royce share price could be worth. If revenues return to 2019 levels, the company’s market value could rise back to £18bn. Today it is £8.8bn.
Of course, this is only a rough, back-of-the-envelope projection. I’ve used sales figures because the company has lost money in four of the past six years. This makes it very difficult for me to place a value on the business based on profitability alone.
It also reduces the chances that the stock will ever return to previous highs. As long as Rolls continues to lose money, I think investor sentiment towards the business will remain week. There’s always going to be a question as to whether or not the company will be able to sustain its losses.
Still, management has stated that the enterprise is aiming to become free cash flow positive next year. If the company can hit this target, it will remove some of the pressure from its balance sheet. However, I should note that the group has missed management growth projections in the past. That’s something investors should keep in mind.
Overall, it isn’t easy today for me to say how much the Rolls-Royce share price is worth. Nevertheless, I would buy a small amount of the stock for my portfolio today as a recovery play.
The post How much is the Rolls-Royce share price really worth? appeared first on The Motley Fool UK.
Rupert Hargreaves has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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 2021