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Over the past five years, Rolls-Royce (LSE: RR) has performed well. Spectacularly well. In fact, over that period, Rolls-Royce shares have soared by 1,112%.
That would be an impressive performance for any business. But for a long-established company in a mature industry, it is nothing short of spectacular.
I have been keeping an eye out for shares I hope could potentially do even part as well in future. Here are a few lessons I have drawn from the incredible ascent of Rolls-Royce shares in recent years.
A temporary crisis is very different to a permanent industry transformation
Five years ago, the Rolls-Royce share price had suffered from weakened civil aviation demand related to government-imposed travel restrictions during the pandemic.
Looked at it from here with the benefit of hindsight, that now looks like a temporary crisis. For Rolls-Royce, at least: for other aviation industry participants like airline Flybe it turned out to be fatal.
At the time though, it was difficult to know whether the crisis would pass, or was part of a seismic shift in travel trends.
A version of the same question could be relevant today when assessing artificial intelligence (AI) shares. Is big tech’s massive spending on AI likely to be a permanent phenomenon, or is it a flash in the pan?
In the moment it can be hard to assess what the right answer will be. But paying attention to indicators that an important phenomenon is temporary not permanent could help investors.
Liquidity always matters
Five years ago, the aerospace engineer had been losing money hand over first. It issued large numbers of new shares and significantly boosted its liquidity so it had hard cash to bide it over a very difficult trading period.
When the economy is strong and conditions smooth a company’s liquidity may not seem very important in practice. But if it runs into big difficulties, the amount of cash it has on hand can make the difference between survival and bankruptcy.
When investing, I always look at the net debt on a firm’s balance sheet, as well as its cash and cash equivalents on hand.
Having a promise of money being available from a lender is not the same as having that money as hard cash, especially during an economic tumult when lenders may also be struggling.
Business moats are powerful
The ascent of Rolls-Royce shares is also a reminder of the importance of looking at what Warren Buffett calls a company’s ‘moat’ when investing. That is his way of talking about a firm’s competitive advantage. Just as a moat helped keep a medieval castle safe from would-be attackers, a competitive advantage can help set a firm apart from its rivals.
With its proprietary engine designs and the high barriers to entry in its industry, Rolls-Royce had strong competitive advantages both five years ago and today.
That is something I look for when hunting for shares to buy for my portfolio. I always ask myself: what moat does this company have that can help give it pricing power and set it apart from competitors over the long term?
