Subdued Growth No Barrier To Rolls-Royce Holdings plc (LON:RR.) With Shares Advancing 28%

The Rolls-Royce Holdings plc (LON:RR.) share price has done very well over the last month, posting an excellent gain of 28%. The last month tops off a massive increase of 106% in the last year.

Since its price has surged higher, Rolls-Royce Holdings' price-to-earnings (or "P/E") ratio of 26x might make it look like a strong sell right now compared to the market in the United Kingdom, where around half of the companies have P/E ratios below 15x and even P/E's below 9x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

With earnings growth that's inferior to most other companies of late, Rolls-Royce Holdings has been relatively sluggish. It might be that many expect the uninspiring earnings performance to recover significantly, which has kept the P/E from collapsing. If not, then existing shareholders may be very nervous about the viability of the share price.

Check out our latest analysis for Rolls-Royce Holdings

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Does Growth Match The High P/E?

Rolls-Royce Holdings' P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.

Retrospectively, the last year delivered a decent 4.2% gain to the company's bottom line. Pleasingly, EPS has also lifted 1,921% in aggregate from three years ago, partly thanks to the last 12 months of growth. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Shifting to the future, estimates from the analysts covering the company suggest earnings growth is heading into negative territory, declining 1.2% per year over the next three years. With the market predicted to deliver 13% growth each year, that's a disappointing outcome.

In light of this, it's alarming that Rolls-Royce Holdings' P/E sits above the majority of other companies. Apparently many investors in the company reject the analyst cohort's pessimism and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as these declining earnings are likely to weigh heavily on the share price eventually.

The Bottom Line On Rolls-Royce Holdings' P/E

Rolls-Royce Holdings' P/E is flying high just like its stock has during the last month. Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

Our examination of Rolls-Royce Holdings' analyst forecasts revealed that its outlook for shrinking earnings isn't impacting its high P/E anywhere near as much as we would have predicted. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings are highly unlikely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Don't forget that there may be other risks. For instance, we've identified 2 warning signs for Rolls-Royce Holdings (1 is concerning) you should be aware of.

If you're unsure about the strength of Rolls-Royce Holdings' business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.