Should I buy Rolls-Royce shares for my ISA?

Rolls-Royce (LSE: RR) is a common share in the portfolios of many UK investors. Indeed, at the end of last year, the company had 168,000 individual shareholders. Of those, 50,000 were small holders with only 150 or fewer Rolls-Royce shares.

Does it make sense for me to add the company to my ISA at the moment? I don’t think so – here’s why.

Long-term investment objectives

One of the first things I would consider is the objectives of my ISA. I hold some shares in it for their income potential. But Rolls-Royce is not currently paying a dividend. In fact, it is unable to resume dividend payments until 2023, due to conditions attached to a loan it drew. Even then, there is no guarantee that dividends will restart.

So, at this point I wouldn’t even consider Rolls-Royce as an income share for my portfolio.

But I do hold some shares for their growth potential. Could Rolls-Royce fit that bill? After all, the Rolls-Royce share price has soared 87% in the past year.

Long-term growth drivers

With that sort of performance in the past 12 months, could the price keep climbing? I think it could, and have previously explained why I think the Rolls-Royce share price could top £2 next year. That would be an increase of about 30% from today’s price, certainly an attractive performance if it comes to pass.

But in terms of the Rolls-Royce share price movement, I see two different dynamics at play. The first is a shorter-term turnaround story. Investors, scared by the share price collapse and dilutive rights issue last year, have been looking for any piece of good news as a reason to mark up the shares. The company has provided a positive stream of updates, for example that it ought to turn cash flow positive in the current six-month period. Positive reaction to this in the City has meant a recent surge in the Rolls-Royce share price. Further good news – for example confirmation that the free cash flow target has indeed been met – could boost the share price further in my opinion.

But that looks closer to trading than investment to me. For my ISA, I would like to buy and hold shares based on long-term growth prospects in the coming years. Here, I have more doubt about whether I should add Rolls-Royce shares to my ISA.

Why I won’t buy Rolls-Royce shares

While the business recovery is promising so far, even if it succeeds, Rolls-Royce will come out of the process a leaner company than it was at the start of the pandemic. It has been borrowing heavily and selling assets – good for  cash flow, but not necessarily to build future success.

It’s also unclear how rapidly and fully demand will return for civil aviation engines, a core part of the company’s business. Many airlines are strapped for cash. Even if passenger numbers recover – which they are a long way from doing on a global basis – airlines may want to drive harder bargains on engine pricing.

In other words, Rolls-Royce faces an uncertain demand outlook and potential downward pricing pressure. Neither of those things commend it to me as a long-term growth story. I therefore won’t be adding Rolls-Royce to my ISA.