Rolls-Royce’s Share Price Has Stopped Rising. Is It on the Verge of Collapse?

At some point, Rolls Royce (LSE:RR) share price needs to stop. It’s up 535% in just two years, for God’s sake. No share can keep going up like that forever.

After such a great run, there is inevitably a lot of froth and speculation in the share price. If the get-rich-quick team goes bust and they chase the next adrenaline rush, Rolls-Royce shares could also fall precipitously.

I wonder if we are at that point. The aircraft engine maker’s shares are up 133% in a year, but only 10% in three months. It is now the 16th largest company in the world FTSE100 with a market capitalization of £42.2 billion, one place above the arms giant BAE Systems.

Rolls-Royce shares are starting to look expensive, trading at 36.38 times earnings. That’s more than twice the FTSE 100 average of 15.3 times.

Is it too late to buy?

Given the transformational leadership of CEO Tufan Erginbilgic, Rolls can justify that top-line valuation. It began August by raising its full-year profit forecast to £2.1bn-£2.3bn, after first-half operating profit jumped 74% to £1.15bn

Revenue in the first half of the year rose 19% to £8.18bn, while cost savings helped lift the operating margin by 4.4 points to 14%. The group is on track to generate free cash flow of up to £2.2bn and will reward shareholders by resuming its dividend. The shares are forecast to yield 1.08% in 2024, with earnings set to rise to 1.23% in 2025.

Much of the recovery has been fueled by aviation’s post-pandemic recovery. Rolls-Royce makes most of its money on aircraft engine maintenance contracts, which are based on miles flown.

Investors remain generally wary of airline stocks because they know how volatile the sector can be, vulnerable to war, terror, strikes, weather and volcanoes. But in the case of Rolls-Royce, investors are having too much fun to worry.

Are FTSE 100 growth stocks too expensive?

I could add a recession to that list of problems. If the United States experiences a hard economic landing, business and consumer travel could fall, and not just in the States. Given the high expectations built into Rolls-Royce’s share price, even a small mismatch in revenue, profit or margins could depress the share price.

There is also a danger that we are all investing too much in Mr. Erginbilgić. He has clearly done a great job. But he was lucky to take over after former CEO Warren East had gone through the worst. I like lucky generals as much as Napoleon, but he has a lot of hard work ahead of him.

Supply chain disruptions remain a concern, and looming trade wars won’t help. There’s huge opportunity in the group’s proposed fleet of mini-nuclear plants, but also huge uncertainty. Green transition and volatile fuel and commodity prices could also drive up costs.

Rolls-Royce stock is slowing down and I wouldn’t be surprised if it was idle or falling. I still think it’s a long-term buy and hold for me. I won’t buy more shares at today’s valuation, but I’ll definitely buy them if they fall.