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The Rolls-Royce Holdings (LSE: RR.) share price hit a high of 1,306.6p on 14 January. But just a fortnight later on 28 January, it closed 7.5% down from that peak, at 1,208p. Investors have been calling an end to Rolls’ astonishing upwards run for some time, with the shares up 1,230% over the past five years.
The thing is, we’re looking at a forecast price-to-earnings (P/E) ratio of only around 20. That’s really not so high compared to so many other growth stocks I’ve seen. And who’d bet against analysts continually upping their price targets?
Morgan Stanley just raised its Rolls-Royce share price target to 1,500p — up from earlier guidance of 1,280p, and 24% ahead of where the stock last closed. A bit earlier, Goldman Sachs upped its target from 1,290p to 1,350p, suggesting a further 12% rise.
My fear is one single thing could derail Rolls-Royce shares at this point. The problem is, I don’t know what that might be. And if you think that’s a pointless thing to say, please bear with me a moment…
A growth stock can issue glowing report after glowing report, continually beating forecasts — just as Rolls has been doing. And then one day, a result comes in that’s less than 110% of what was expected — and the shares plunge. We can never know what that might be. But we can know that the same scenario has played out repeatedly in the past.
For Rolls-Royce, my main fear is over forecasts showing a big earnings jump in 2026, followed by a drop in 2027 which could push the P/E to 37. If Rolls fails to do better than that, might it be the thing?
How to handle risk
So what should investors who are getting a bit nervous do? One approach is to take some profit and reduce the risk. An investor might, for example, sell enough to recoup their initial investment. And then consider everything else left in the market as profit. Alternatively, they could take out their gains and leave the initial stake in the hope of further rewards. Or somewhere in between — it’s all down to individual appetite for risk.
And then there’s a common saying along the lines of: “Cut your losses and let your winners run.” Hang on, doesn’t that contradict the idea of taking profit off the table? It sure does. But the one big downside of following investing rules of thumb is… there always seem to be more rules out there than there are thumbs.
Forget rules
For me, there’s only one sensible approach. That’s to ignore snappy strategy quotes — and don’t base decisions on share price alone. It’s all about valuation. Oh, and diversification. I aim for a diverse set of stock holdings with minimum risk, not too much in any one, and all with individual valuations I think are fair.
We can surely do better by protecting ourselves against share prices falling than trying to predict them. And if Rolls-Royce fits our valuation and risk criteria, consider going for it.
