It isn’t usually a UK inventory seems on a US firm’s funding checklist. However as 2025 approaches, Rolls-Royce (LSE:RR) shares are prime of 1 agency’s portfolio – and it’s not simply any US firm.

It’s the Sequoia Fund. I don’t spend a lot time taking a look at what different traders are doing as a rule, however there are a number of exceptions – and that is one among them. 

Buffett’s solely advice

In 1969, Warren Buffett determined he couldn’t see engaging funding alternatives within the inventory market. So he made his one-and-only advice for traders: the Sequoia Fund.

On the time, this was run by Invoice Ruane. To not be confused with Sequoia Capital – a enterprise capital operation – the agency was targeted on rules that align with Buffett’s personal and stays that means right this moment. 

These embrace pondering just like the proprietor of a enterprise and shopping for shares in corporations to carry for the long run. And because the fund started, this technique has outperformed the S&P 500 by greater than 2% a yr.

Heading into 2025, Rolls-Royce shares are the corporate’s largest holding, accounting for round 10% of its total portfolio. I feel that’s one thing value being attentive to.

Progress sources

Over the past couple of years, Rolls-Royce shares have primarily been pushed by a restoration within the variety of flying hours. However even with this stabilising, Sequoia sees longer-term alternatives forward.

In a letter from this yr, the agency recognized two main sources of development for Rolls-Royce. The primary is engine innovation in its civil aerospace division, which is round 50% of whole revenues.

The second is new contract wins within the defence section. Whereas the payoff for these is additional sooner or later, Sequoia’s anticipating important returns beginning on the finish of the last decade.

These are ongoing long-term sources of development that designate why the fund hasn’t been promoting its stake in Rolls-Royce. But it surely additionally hasn’t been including to its funding. 

Valuation

Sequoia’s investor letter from this yr stated the next:

“When we consider near-term business growth, the £1.5 billion or so likely to be realized via non-core asset sales, and the working capital efficiencies that Erginbilgiç and his team are working to unlock, we figure that the company is likely to generate free cash flow over the next four years amounting to upwards of half its current market capitalization”.

That’s clearly a pretty proposition, however the Rolls-Royce share price was £3.01 on the time the letter was launched. It’s round £5.75, as I write this, which adjustments the equation a bit.

Even when all the anticipated money continues to be to be returned, this now accounts for round 26% of the present market-cap. Over the subsequent three years, that’s nonetheless an excellent return, nevertheless it’s a lot lower than it was.

There are additionally clear dangers. Something that disrupts flying hours – akin to a pandemic, an Icelandic ash cloud, or a recession – has a big effect on the agency’s income and the rewards on provide must justify this.

I’m not shopping for

Sequoia’s neither shopping for nor promoting Rolls-Royce shares proper now. And I’m not shopping for both. Whereas I assumed the inventory was considerably undervalued initially of this yr, I’m not so positive going into 2025.