Short-term stock market movements can be driven by emotions. Between April and October last year, Rolls-Royce (LSE: RR) shares rose by 40% to 150p, as investors celebrated the reopening of travel markets.
Since then, the shares have gone into reverse and fallen by nearly 45%. Are these wild swings really justified by the company’s actual performance? I don’t think so. I was cautious last year, but with the stock now trading under 90p, I’m tempted to add Rolls-Royce shares to my portfolio in May.
Why has the stock slumped?
Let’s start with a look at the problems that might be causing investors to avoid Rolls-Royce. Back in December, we had the Omicron variant.
Since then, surging inflation and the war in Ukraine have grabbed headlines. Economists have started to worry about the risk of a recession.
That’s not all. Rolls’ highly-rated chief executive, Warren East, has resigned. And on a longer view, it’s still not clear how engineers such as Rolls-Royce will manage to reduce the carbon emissions from jet engines.
So many possible risks. Surely, I should be avoiding Rolls-Royce, not thinking about buying?
I’m looking forward, not backwards
We won’t know when Rolls-Royce shares have bottomed out until it’s too late. But what I’m seeing now is that airline executives are talking very bullishly about demand for air travel.
In an press briefing in March, Delta Air Lines CEO Ed Bastian told journalists that the North Atlantic market was seeing heavy demand. That could be good news for Rolls-Royce. Long haul routes across the Atlantic are a key market for its engines.
Then in April, Bastian told the Financial Times that the airline had just had the busiest five weeks for ticket bookings in its entire history. He’s also said that passenger demand is so strong that airlines are able to pass on fuel costs through higher ticket prices.
Rolls-Royce shares: contrarian opportunity?
Airlines executives are now talking about how to meet surging demand, rather than how to survive a shutdown. In my view, Rolls-Royce’s recovery will inevitably follow that of air travel.
In uncertain times like these, I reckon it pays to listen to wiser and more experienced voices. Not me, obviously. I’m thinking of billionaire investor Warren Buffett, who once warned investors that “the future is never clear; you pay a very high price in the stock market for a cheery consensus.”
When investors were cheery about Rolls-Royce in September, the shares cost more. Today, I can buy the same business for 40% less. That seems attractive to me.
City analysts have trimmed their earnings forecasts for Rolls-Royce over the last few months. But the shares still look quite affordable to me, on 24 times 2022 earnings, falling to 16 times earnings in 2023.
I’d be happy to buy Rolls-Royce shares in order to tuck them away for a few years while air travel recovers.
Although this investment might carry more risk than some FTSE 100 stocks, I think it could turn out to be a very profitable opportunity for my long-term portfolio.