Usually, I’d look for an income stock having a good track record of dividend payments before I’d consider buying it. However, I do make exceptions for companies that might start to pay a dividend shortly. If the future outlook for payments is good, it can be worth the risk to buy now. This is potentially the situation unfolding with Rolls-Royce (LSE:RR) shares.
Why dividends have stopped
For the years between 2000 and 2020, Rolls-Royce paid out a constant dividend. Yet due to the impact of the pandemic, this was cut to zero in 2020. This was much needed, given the loss after tax of over £3bn for the 2020 full year.
The dividend hasn’t been resumed since then. Losses have shrunk, but the 2022 loss of £1.19bn made it out of the question to pay out a dividend.
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However, 2023 has been a different story. This is clear from the incredible 178% jump in the share price over the past year. Investors are definitely in a better mood about the future for Rolls-Royce, and for good reason.
Why things have changed
The H1 2023 results showed a profit before tax of £524m, with an outlook for this to continue. If realised, this would equate to a profit of over £1bn for the full year. Since dividends are mostly paid out of earnings, it’s the first real sign since 2020 that this could be a viable income stock.
Another positive sign was the note made in the 2022 results. It said that “we are committed to returning to an investment grade credit rating through performance improvement and to resuming shareholder payments.“
Granted, this didn’t specify when payments would be resumed. But it’s clear that management is aware shareholders are keen to receive dividends and that it’s a focus going forward.
The dividend forecast
At the moment, analysts don’t expect a dividend in February next year. Yet the forecast is for a 0.45p payment with the half-year results later in 2024. Then in 2025 the forecast is for payments of 0.95p and 0.7p.
From this I can see that Rolls-Royce is due to become an income stock next year. However, the dividend yield is something to be noted. If I assume the share price of 236p stays the same, the yield would be 0.19% in 2024. For 2025, this could increase to 0.7%.
Therefore, it’s key to note the difference between a stock paying a dividend and one that’s actually worth buying. There’s definitely a case to be made for buying Rolls-Royce shares for capital appreciation. But my focus here is solely on the dividend potential.
From that angle, I don’t see Rolls Royce as a viable income stock to consider buying now. This is based on the low yield potential. If we see the earnings beat expectations and the dividend forecast to rise, I’d look to reconsider things.
