Rolls-Royce (LSE:RR) joined the ranks of the FTSE 100 dividend shares this week. The company announced plans to distribute 30% of its underlying earnings after tax to shareholders from 2025.
The stock market’s taken the news very positively, sending the stock up 11%. So is this now one for passive income investors to consider buying?
What’s it worth?
The first question for investors is what will 30% of underlying earnings after tax look like? Rolls-Royce says this is the same as ‘underlying profit for the period’.
During the first half of 2024, this came in at £737m. Doubling that (to get to the full year) hits £1.47bn, so 30% of that is around £442m.
Right now, Rolls-Royce has a market cap of just under £42bn. That means the implied dividend yield based on these calculations is slightly above 1%.
I suspect passive income investors aren’t going to find that hugely exciting. So the investment case is going to come down to the company’s ability to grow its earnings – and its dividend – from here.
Growth outlook
According to Rolls-Royce, the business is on track to hit its medium-term targets. Those include operating profits of between £2.5bn and £2.8bn a year.
During the first half of 2024, the company managed £1.1bn in operating income. And CEO Tufan Erginbilgiç has said the firm should manage roughly the same again in the next six months.
This means the business is actually quite close to its stated targets. But that probably doesn’t leave a huge amount of room for dividend growth going forward.
As a result, I’m dubious about the prospects for significant dividend growth going forward. And I think investors looking for passive income should probably think they have more attractive options.
Too late to buy?
It would have been a different story a year ago – the stock was 62% cheaper then than it is today. And that makes a difference to the likely dividend yield.
Investors who bought the stock last August would be looking at a prospective return of 1.6%. That doesn’t sound like much, but it’s 60% more than someone buying the stock today.
There are also important risks to consider. The most obvious of these right now is the cyclical nature of demand for air travel, as Ryanair has announced weakness in holiday bookings for this summer.
Rolls-Royce isn’t directly impacted by this, since its engines largely feature in long-haul aircraft. But I think investors would be unwise to rule out the possibility of a similar volatility in this space.
Dividends
A company announcing a dividend has traditionally been seen as a sign of weakness. It indicates management can’t find a way to use its excess cash to make the business grow.
With Rolls-Royce though, the situation’s different. The firm returning to paying dividends is evidence the business has fully recovered from the pandemic.
The trouble for investors is that the share price is also at a level that seems to reflect the anticipated growth. As a result, I think investors have better opportunities elsewhere.
The post Is Rolls-Royce now one of the best dividend shares to buy? appeared first on The Motley Fool UK.
Investing in AI: 3 Stocks with Huge Potential!
🤖 Are you fascinated by the potential of AI? 🤖
Imagine investing in cutting-edge technology just once, then watching as it evolves and grows, transforming industries and potentially even yielding substantial returns.
If the idea of being part of the AI revolution excites you, along with the prospect of significant potential gains on your initial investment…
Then you won’t want to miss this special report inside Motley Fool Share Advisor – ‘AI Front Runners: 3 Surprising Stocks Riding The AI Wave’!
And today, we’re giving you exclusive access to ONE of these top AI stock picks, absolutely free!
Get your free AI stock pick
More reading
The Rolls-Royce share price jumps 9% as dividends are reinstated and profits rise by 74%
If I’d put £1,000 in Rolls-Royce shares 6 months ago, here’s what I’d have now
The Rolls-Royce share price could skyrocket tomorrow! I’m ready for it
It’s almost crunch time for Rolls-Royce shares!
The Rolls-Royce share price is down 10% since a 52-week high. Is this a buying dip?
Stephen Wright has no position in any of the shares mentioned. The Motley Fool UK has recommended Rolls-Royce Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
