The Rolls-Royce (LSE:RR) five-year share price chart is a thing of beauty. It moves ahead, as if on a runway, before soaring into the air like an Airbus powered by Rolls-Royce engines.
By now, most shareholders are well up and enjoying the view. But has this FTSE 100 stock gone way too high after skyrocketing 2,750% in just over five years? How long before major turbulence hits?
Overextended
To get a potential answer, I turned to ChatGPT. I first asked: Is the Rolls-Royce share price in a bubble?
Diving straight in, the bot said “there are warning signs that the Rolls-Royce share price is showing frothy traits“. These include a high forward-looking price-to-earnings (P/E) ratio, which it pegged at between 37 and 42.
The actual figure is 34 for next year. But the point is correct. Rolls-Royce is trading at a premium today, which adds risk if future earnings disappoint.
Nevertheless, ChatGPT noted that the engine maker is benefitting from “strong industry tailwinds“. These include international travel recovering strongly from the pandemic and higher defence spending. Rolls-Royce also has exposure to nuclear power, which is back in vogue due to surging AI-related demand.
ChatGPT pointed out that ‘bubble’ implies a speculative irrationality decoupled from fundamentals. Instead, it sees Rolls-Royce stock as “overextended” and “possibly in the late innings of re-rating”.
In other words, the stock’s probably a bit stretched rather than in a bubble.
Crash scenario
Next, I asked the AI bot for the date of the next Rolls-Royce share price crash. Of course, it wouldn’t go there, but it did outline a crash scenario where a major recession slashes airline flying hours and rising supply chain costs hurt margins.
This last one is possible. China’s new rare earth export curbs could raise costs and further disrupt supply for defence firms, including Rolls-Royce.
To mitigate these risks, Rolls-Royce has dedicated teams embedded at key suppliers. And the number of critical suppliers on its watch list has fallen from around 15 to 10. In the first half, the company saw a 15% improvement in parts delivered.
Another possible crash trigger, according to ChatGPT, is a geopolitical détente that cuts defence orders. This one is very unlikely, in my eyes. European defence spending is almost certainly going to rise significantly in future (out of necessity, sadly). So I remain bullish on the company’s defence division moving forward.
The timeframe for this hypothetical crash would be 2027-2029, speculates ChatGPT. It said if earnings disappoint and the forward P/E ratio compresses to “a more realistic 15 times”, shares could “retrace 40%–60%” from current highs.
My view
The bot made some valid points. But while investors remain bullish on defence spending and AI/nuclear power, I doubt the stock’s forward P/E multiple will compress to 15.
As for ChatGPT, it has come a long way, but still occasionally spits out inaccuracies. When I point these out, it nonchalantly says things like “well spotted“. In this sense, it’s a bit like a confident bluffer, and therefore can’t be relied upon (yet) for fundamental stock research.
Overall though, I agree that Rolls-Royce stock is probably overextended but not in a bubble. The company is due to release a Q3 trading statement in November. Investors might want to wait for that before deciding their next move.
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