I often think of value stocks as companies with low earnings multiples and a share prices on the floor.
Therefore, Rolls-Royce Holdings (LSE: RR) may seem an unlikely value candidate, given the engine maker’s explosive move higher since October 2022.
However, stock market legend Warren Buffett and his billionaire investing partner Charlie Munger used to agree that value and growth are joined at the hip. In other words, the growth of a business is an important component of its value to an investor.
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A growing business
Therefore, although Rolls-Royce stock, near 297p, isn’t changing hands at a bargain valuation, there’s plenty of growth potential in the business. So that means there’s probably value to be had by investors prepared to invest for the longer term.
In November 2022, the company said it’s targeting a step-change in mid-term performance. The directors have a “clear vision and strategy” aimed at creating a high-performing, competitive resilient and growing business.
The better performance will drive a stronger balance sheet, the directors said. Meanwhile, the new focused strategy has helped to identify investment priorities and partnership opportunities. One part of the plan is to make disposals of non-core assets worth between £1bn and £1.5bn over a five-year period.
Chief executive Tufan Erginbilgic said Rolls-Royce is at a “pivotal point” in its history. Meanwhile, City analysts have pencilled in a chunky 30% increase in earnings for 2024.
It seems the business is emerging from its stressful period through the pandemic in far better shape than when entering it. The enterprise had been struggling for some time before coronavirus hit. By 2018, annual profits had turned into annual losses.
Leaner and more efficient
The pandemic and its lockdowns caused the business some severe damage. The company earns a lot of its revenue from maintenance agreements linked to aircraft flying hours. So the grounding of most of the world’s commercial planes turned off much of the company’s revenue and cash flow.
For a while, the business was in deep trouble. It even looked possible for it to fail completely. But a financial rescue package saved it. The recovery in the business has been dramatic since, with the stock starting its catch-up move at the end of 2022.
My impression is the company’s period spent teetering on the edge of the cliff-of-oblivion has actually done it some good! It seems that a reborn, leaner and focused enterprise has emerged with decent-looking forward prospects for growth.
However, it’s worth remembering the company has also just demonstrated its vulnerability to geopolitical and macro-economic events. So future growth is not guaranteed. It’s even possible for shareholders to lose money on the stock.
Nevertheless, I see the business as well worth further research and consideration right now. It could make a useful addition to a diversified portfolio of stocks held for the long term.
We’ll find out more from the company with the full-year earnings release due on 22 February. In the meantime, I’m watching closely for an opportune entry point, such as on market dips and down-days.
