It’s been a reasonably good year for the FTSE 100. The UK large-cap index has climbed more than 10% in the last 12 months and is sitting just shy of an all-time high.
There have been some big winners and losers in the index. One company in particular has grabbed my attention on the back of some stellar gains in the past year.
FTSE 100 treasure or trash?
The stock that I’ve been watching is Rolls-Royce (LSE:RR). Shares in the group have rocketed over 400% since the end of 2022, including 116% in the last 12 months, to sit at 475p.
The first thing I really like about Rolls-Royce is its strong earnings base. CEO Tufan Erginbilgiç has delivered brilliant results that have helped fuel the company’s shares higher.
For starters, full-year profit guidance was lifted from £2.1bn to £2.3bn in August, as the engine maker boosted first-half revenues up 19% to £8.2bn.
I’m a big believer that cash is king. Rolls-Royce is forecasting to have plenty of it, with forecast free cash flow of £2.2bn and a dividend for shareholders on the way.
Despite the strong results, I think questions on valuation are warranted when a FTSE 100 stock surges so high, so quickly. There are sellers taking profits, buyers late to the party, and those that still smell a bargain.
Aviation has been a big driver of the stock’s fortunes in recent years. One thing that has me nervous is the in-built assumptions behind the current share price.
We saw some of this in action this week. Rolls-Royce shares fell on Monday when engine component failures were identified on 15 of Cathay Pacific’s A350 planes. After announcing these issues could be resolved by 7 September, the FTSE 100 stock rebounded the very next day.
What’s the verdict?
It’s clear Erginbilgiç has delivered results since taking over in January 2023. However, the current valuation has me a touch worried.
A price-to-earnings (P/E) ratio of 17 isn’t outrageous on its own. It does mean there is a lot of built in growth and margin expectation in the current valuation. Higher fuel costs or lower passenger numbers in a recession could spell trouble.
I think there’s a little bit further to run for Rolls-Royce shares in 2024. However, taking a long-term view, I think it’s one I’m not ready to buy.
Should we see the FTSE 100 stock fall and a P/E ratio more in the mid-teens then I’d be ready to dip my toe in and invest. In the meantime, I’m focusing my efforts on finding some gems in more defensive sectors like Consumer Staples.
This post was originally published on Motley Fool
