The risks are rocketing for Rolls-Royce shares – time to bank that profit?

Rolls-Royce (LSE: RR) shares are a wonder of the investment world. They’ve jumped over 1,000% in three years. Early 2020s investors have seen life-changing gains, smashing the myth that FTSE 100 shares are dull. Even latecomers have done well, with the stock up 97% in the last year. New investors might be tempted, while old hands may be wondering if it’s time to get out while the going is good. Should they hit the ejector seat?

FTSE 100 powerhouse

Rolls-Royce was helped by how badly beaten down the shares were after the pandemic. CEO Tufan Erginbilgic shocked investors and staff by publicly shaming it as a “burning platform” when he took over in January 2023. But that also gave him the freedom to make tough calls, and it has paid off faster than even he could have imagined. Profits are climbing, free cash flow surging and debt falling. Dividends have returned and a £1bn share buyback has boosted confidence further.

The post-Covid civil aviation recovery has certainly helped, as the company makes a huge chunk of its income from aircraft engine maintenance contracts, which are based on miles flown. But defence is also booming, boosted by Western efforts to counter China and Russia.

Rolls-Royce’s power systems division, which runs engines for data centres and back-up generation, enjoys rising demand as AI infrastructure expands. Its small modular reactors offer a fresh growth opportunity. The group’s diversification provides a cushion against setbacks in any of these areas.

Valuation stretch

The higher the share price climbs, the bigger the risks. The price-to-earnings ratio has now soared to around 52, far above the FTSE 100 average of 18. Investors are pricing in a lot of extra growth, and if Erginbilgic struggles to deliver, the shares could slip. Peace talks in Ukraine appear to be hitting sentiment towards defence stocks. Rolls-Royce has lost 5.5% over the last month, and BAE Systems is down 11%.

While those mini-nukes are brilliant long-term opportunities, building nuclear plants is the work of years, decades even, and depends on political will. There are clearly risks, and yes, I’m a little wary.

Buy, Hold or Sell?

Personally, if I didn’t hold Rolls-Royce, I wouldn’t be buying today. But since I do, I’m holding. The company is a terrific example of British engineering, and I believe its long-term prospects remain strong. However, in the short run things could get bumpy. Expectations are dizzyingly high. Investors might still consider buying but I’d suggest taking a minimum 10-year view and get ready for hiccups along the way. Or maybe wait for a dip.

Rolls-Royce shows what happens when leadership makes tough decisions, focuses on operational excellence, and enjoys a bit of luck too. I plan to stick with this one for the long haul. Investors hunting the next big recovery play might want to look elsewhere. I can see plenty of potential on the FTSE 100 today.

The post The risks are rocketing for Rolls-Royce shares – time to bank that profit? appeared first on The Motley Fool UK.

More reading

• Down 12% in weeks, has the Rolls-Royce share price started a downwards slide?
• How on earth are Rolls-Royce shares up 1,556% since 2022?
• £20,000 invested in Rolls-Royce shares 5 years ago is now worth £220,000! What’s next?
• Could these 3 threats derail the Rolls-Royce share price?
• Do Rolls-Royce or Lloyds shares offer the better value?

Harvey Jones has positions in BAE Systems and Rolls-Royce Plc. The Motley Fool UK has recommended BAE Systems and 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.

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