Are investors taking a big gamble chasing Rolls-Royce shares higher and higher?

There’s a big question in many investors’ minds about Rolls-Royce Holdings (LSE: RR.) shares. When will it be time to get off the ride, pocket the profits, and move on to something else?

Knowing when to sell can be the most difficult investing decision there is, especially for growth share investors. The share price might have fallen a bit since the Iran conflict kicked off. But it’s been through dips before, and then turned back and continued its upward path.

Even with the latest wobble, we’re still looking at a 10-bagger over the past five years. So the temptation to cash in must be strong. But against that, Rolls Royce shares are now down 18% since their 52-week high. And we might look on that as a new buying opportunity.

How should an investor think about solving this dilemma? Let’s take a look.

More to come?

For some time, I’ve been expecting the Rolls-Royce share price to end its soaring run and then start to fall back. But that’s not through any great insight — it’s just long years of experience watching growth share cycles. And that’s the easy part. Guessing at when any reverse is likely to happen, or what the highest price level might be… well, I don’t know anyone who can pull that off. And my focus on the risk has meant I missed out on some cracking profits.

What’s the solution? For me, it has to be to forget about the share price history and instead look at valuation. Seeing how high a stock like Rolls-Royce has already risen tells us nothing whatsoever about its future prospects.

On the valuation front, however, I don’t much like what I see. Is a forecast price-to-earnings (P/E) ratio of 32 good value for Rolls right now? At around twice the long-term FTSE 100 average, I’m not convinced it is. Growth stocks do often command a premium, and it can be deserved. But, at the very least, I see little or no margin for safety here.

Shifting focus

Much of the current valuation of Rolls-Royce shares will be due to the outlook for the company’s power technology — notably those modular nuclear reactors. And yes, this is a world in which energy needs are soaring — and oil and gas usage really will have to decline some time. So there surely is solid long-term hope here.

But it remains a fact that Rolls-Royce still depends on the aviation business for the bulk of its income. And that market is riddled with uncertainties — even when there’s no war in the Middle East. Those uncertainties are largely beyond the control of airlines, aeroplane makers, and Rolls-Royce.

So what’s my bottom line? I can understand why those with greater risk tolerance than me might still see Rolls-Royce in a positive light even at today’s valuation levels. And they might well be right. But I think investors with a keen eye for valuation should consider putting their cash somewhere else.

The post Are investors taking a big gamble chasing Rolls-Royce shares higher and higher? appeared first on The Motley Fool UK.

More reading

• Rolls-Royce’s share price has plunged 16% from its highs! Time to buy?
• Could a market crash provide a once-in-a-decade chance to buy Rolls-Royce shares?
• Should investors consider Rolls-Royce shares as war rocks global markets?
• What I look for when searching for shares to buy
• Down 15% in days, are Rolls-Royce shares suddenly a bargain again?

Alan Oscroft 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.

See author's posts