If I had invested £1,000 in Rolls-Royce (LSE: RR), a year ago, my stake would now be worth around £2,873! That is quite a return. But even buying Rolls-Royce shares at the start of 2024, I would have seen the value of my holding increase by 40% already, in a matter of months.
Clearly, there has been huge momentum in the engine maker’s shares lately.
But could things move even higher from here?
Imagine I invested £1,000 this week. Here is what might happen.
Sideways share price move potential
Past performance is not necessarily a guide to what will happen next. So, although Rolls-Royce shares have soared in altitude, they could now enter a holding pattern. I might end the year with a holding worth more or less what I paid for it.
At the moment, the dividend is suspended and I do not expect it to come back this year, although management has said it plans to bring back the shareholder payout once finances are strong enough.
Ongoing upwards momentum – or sudden drop?
So far, the rise in Rolls-Royce shares may look like it has defied gravity.
But that partly reflects a low base.
After all, in 2020 the price collapsed as customer demand in the core civil aviation business plummeted in a matter of weeks.
Despite the rise, the shares trade on a price-to-earnings ratio of 15. That does not strike me as unduly expensive given the firm’s unique technology, large installed customer base and strong order book.
Given an aggressive medium-term plan to improve financial performance, the prospective valuation arguably looks cheap. On that basis, I think buying £1,000 of Rolls-Royce shares now could see me ending the year sitting on a paper gain — perhaps a sizeable one.
What if the company does not demonstrate the right progress in meeting those goals, however? After all, it has a long history of mixed business performance even when sales were strong.
Additionally, an unforeseen event that suddenly and dramatically affects sales – as travel restrictions during the pandemic did – could throttle profitability.
That might send Rolls-Royce shares into a tailspin by the end of the year, leaving me sitting on a significant paper loss.
Another risk I see is that, even if the business performs satisfactorily, some investors will try to lock in their recent strong paper gains by selling Rolls-Royce shares. That could depress the price.
Not checking in for the journey
As a long-term investor, though, my horizon lies beyond the next few months.
Momentum can influence a share price, but over the long run, I expect business fundamentals to shine through.
On that basis, I think there could still be potential value in adding Rolls-Royce shares to my portfolio now.
But the risks do not sit well with me. I am particularly concerned that the current share price offers me little margin of safety if sales suddenly get blown off-course due to an event outside the company’s control, like a pandemic or terrorist scare leading to airlines grounding their fleets.
So, I have no plans to invest.
This post was originally published on Motley Fool
