Image source: Rolls-Royce plc
There’s really no contest — Rolls-Royce (LSE: RR.) shares have been the best FTSE 100 stock to hold in recent times. We’re talking about a 1,500% gain in just five years.
But if history is any guide, every party must come to an end at some point. No share price heads upwards in a straight line, at least for very long.
Does it make sense to say that investors are now holding a ticking time bomb?
The only way is up (again)?
At face value, the answer seems clear. Momentum is a powerful force in investing and betting against the market is only for the brave.
Moreover, Rolls-Royce is clearly doing (very) well. Operating profit, margin and free cash flow continue to head in the right direction as the civil aerospace sector looks to be far more robust than it once was.
Elsewhere, the increase in defence spending by governments hasn’t done any harm to that part of the business.
Investors are excited about other potential growth opportunities too (like small modular reactors).
The balance sheet looks to be in far better shape than it did a few years ago as well. A net debt position has now been replaced with net cash. Dividends, while not massive, have also returned to the mix.
No wonder the share price has almost doubled in 2025 alone.
Tick, tock
The trouble is that a lot of the above seems to be already reflected in the valuation.
Put simply, Rolls-Royce looks priced to perfection, at least to this Fool. A price-to-earnings (P/E) ratio of 41 for the current financial year is eye-wateringly high. Even an anticipated 14% rise in earnings per share next year is only enough to bring the P/E down to 36.
In other words, anyone considering buying today needs to be very confident that everything will go right from here.
Maybe it will. But I can see at least a few reasons for being cautious.
Here’s what might go wrong
As a big supplier of engines, Rolls-Royce is heavily exposed to the aerospace sector. Should something like the pandemic come along again, airlines are likely to be hit hard. Yes, those engines will still need to be maintained but I’m not sure current investors will want to stick around.
If the probability of another pandemic so soon seems low, replace that with a global recession. A jump in fuel prices or simply a lot of bad weather might be enough to upset some holders.
Second, it’s fair to say that CEO Turfan Erginbilgic has done a stellar job of turning this company around. However, it might only take a slight earnings miss, issues with the supply chain, cost overrun or contract delay to get investors twitching. This is even if we don’t get any of those nasty scenarios mentioned above.
Too rich for me
Of course, I don’t know where the Rolls-Royce share price is going any better than anyone else. Calling the top is as tough/impossible as calling the bottom.
A ticking time bomb? Nobody can really say for sure.
Right now however, my own risk tolerance and desire to avoid more cyclical businesses means I’m steering clear. If we do get a general market crash, I may consider picking this stock up if the price is right.
