Should I Buy Rolls-Royce Holdings?

LONDON -- It's time to go shopping for shares again, but where to start? There are loads of great stocks to choose from, and I've got my wallet out. Does Rolls-Royce Holdings offer investors a smooth ride?

High roller
There's change at the top of Rolls-Royce Holdings, with Ian Davis, who previously served at BP, Johnson & Johnson and McKinsey & Company, replacing outgoing chairman Simon Robertson after eight years. Davis has shown his commitment by shelling out £55,500 on the company's shares. Sadly, I don't have that kind of money to hand, but should I also buy Rolls-Royce?

March of the maker
Airplane engine maker Rolls-Royce Holdings is one of those great British engineering companies that we pretend we no longer have. But investors know a top quality operation when they see one, and its stock is up 34% over the past 12 months. So what has driven this splendid performance?

Only a handful of global companies do what Rolls-Royce does, and the barriers to new entrants are high, putting it in a strong market position. Full-year 2012 results were robust, with Rolls-Royce increasing its underlying profits for the 10th consecutive year, up 24% to £1.4 billion. It produced a record number of power systems, which have the added bonus of producing many years of aftermarket service revenues. Group profit margins hit 12.2%, up from 10.7% in 2011. Management is looking forward to "modest growth in underlying revenue and good growth in underlying profit" in 2013. Assuming it takes you five seconds to read this sentence, two Rolls-Royce-engined aircraft will have either taken off or landed by the time you finish it. When Chancellor George Osborne was recently talking about the "march of the makers", he was talking about companies like Rolls-Royce.

Defense investment
It isn't all clear skies. Rolls-Royce has also been tainted with scandal, with the Serious Fraud Office investigating allegations of malpractice in China and Indonesia. Fines, prosecutions and reputational damage could follow. The group has large pension liabilities, recently rising to £148 million. Despite its recent power play, it isn't immune to global economic headwinds. Cuts in defense spending, both in the U.S. and U.K., are a big worry, although the recent decision to allow the Ministry of Defense to roll over £1.6 billion of unspent money eased investor worries. There's strength in diversity, and Rolls-Royce has a thriving civil aerospace operation. Its share price also benefited from the government's plan to invest £1 billion in the aerospace industry.

Operating margins look healthy at a current 9.9%, but chief executive John Rishton is looking enviously at big U.S. competitors such as General Electric and Pratt & Whitney, whose lower costs allows them to offer lower prices, and invest more in infrastructure and training. Dividend investors will be disappointed by its 1.8% yield, although covered three times, there is scope for growth. Management recently hiked the full-year payment 11%, although the forecast yield for 2014 is just 2.2%.

Roll on
Rolls-Royce is up 172% over five years, and an incredible 2,000% over 10 years, the best performer on the FTSE 100. Earnings per share growth is forecast for 11% in 2013 and 8% next year. Momentum investors will like this stock (it certainly isn't for contrarians). The good news is out there, and at 18.7 times earnings, more than fully priced in. When I looked at this stock in mid-February month I thought looked a little pricey at £10.22. It is up nearly 9% since then. You get Rolls-Royce performance, but pay a Rolls-Royce price.

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Harvey Jones has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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