Image source: Rolls-Royce plc
It is hard to believe that Rolls-Royce (LSE: RR) shares sold for pennies as recently as 2022. With the Rolls-Royce share price now north of £11, some long-term shareholders have done very well in just a few years.
Could the share go on to hit £12? Ought I to buy?
More space for price growth ahead!
In short, I think the share price could indeed hit the £12 mark.
To justify that claim, think about what has been driving Rolls-Royce shares so far in their impressive ascent.
It is easy to say that part of the reason for the meteoric rise has been momentum. In other words, investors have piled in as they have a fear of missing out, watching how well others are doing.
Momentum could continue to push the shares upwards, I reckon, though it is always important to remember that momentum can suddenly flip around without warning. The force that pushes a share price up can also be powerful pushing it down.
But momentum has not been the only reason Rolls-Royce shares have been doing so well.
There is also a strong story behind the momentum — that demand growth is strong in Rolls-Royce’s end markets, the company has a compelling proposition and it is also wringing unnecessary costs out of its operation.
A business in clover
By way of support for that story, one need look no further than the company’s current full-year targets.
The company now expects to deliver operating profit of £3.1bn-£3.2bn and free cash flow of £3.0bn-£3.1bn for the year. Its medium-term targets are even more aggressive.
That is very impressive for a business that was on its knees five years ago, selling new shares for pennies to shore up liquidity.
What I think investors have particularly warmed to is the fact the company has established credibility when it comes to demanding business goals.
In recent years it has set such goals on multiple occasions, successively upgrading them. That is catnip for the City!
Here’s my concern about the share price
Based on that, hitting a £12 share price does not seem unrealistic.
It implies a 6% increase from the current price. That looks like small cheese, given that Rolls-Royce shares are already up 92% since the start of this year alone (and 1,728% over five years!)
The current price-to-earnings (P/E) ratio of 17 is not cheap in my opinion. But I do not think it is outrageous, either. Even at a £12 share price, the P/E ratio would only be around 18. That is barely half the P/E ratio of US rivals like Raytheon.
With its large installed user base, pricing power, and strong demand in civil aviation, defence, and power systems, I see a lot to like about Rolls-Royce right now.
But that strong demand could always disappear at any moment. The cyclical nature of civil aviation demand has been seen on multiple occasions before, with something like a terrorist attack or pandemic suddenly seeing passenger demand collapse.
That risk alone puts me off buying Rolls-Royce shares at their current price.
