It took Rolls-Royce (LSE:RR.) a time to recover from the pandemic and start paying dividends on its shares again.
It got the ball rolling again with a 6p per share reward last year, and with its balance sheet repaired and earnings booming, City analysts expect spectacular dividend growth over the medium term.
Here I’m asking a simple question: should investors consider buying Rolls-Royce for passive income today?
Dividend growth
| Year | Dividend per share | Dividend growth | Dividend yield |
|---|---|---|---|
| 2026 | 8.8p | 46.7% | 0.8% |
| 2027 | 10.1p | 14.8% | 0.9% |
| 2028 | 11.4p | 12.9% | 1% |
Rolls-Royce has never been famed for the size of its dividend yields. Making plane engines, nuclear reactors and defence systems requires massive amounts of capital. This reduces the amount of free cash flow that’s left over to distribute to shareholders.
But even by historical standards, the size of the engineer’s yields through to 2027 are pretty underwhelming.
Under its reinstated dividend policy, it seeks to pay out between 30% and 40% of underlying profits each year in dividends. It’s a moderate rather than low payout ratio, yet Rolls-Royce’s ongoing share price strength has pulled the near-term yield below 1%.
This is something income investors may forgive though, considering the stunning rate of payout growth tipped over the near term. A growing dividend helps protect income from rising inflationary pressures.
At almost 47% for 2025, the rate of growth for this year smashes expected consumer price inflation (CPI) of 3.5% and then some. Dividend growth is expected to slow in 2026 and 2027, but still remains elevated in double-digit territory.
Strong forecasts
While City analysts are confident of more fast-rising dividends, remember that shareholder payouts can never be guaranteed. In the case of Rolls-Royce shares though, I think the engineer’s looking good to hit current forecasts.
Predicted annual dividends are covered between 3 times and 3.2 times by expected earnings through to 2027. Any reading above 2 times provides a wide margin of safety in the event of profits disappointing.
The FTSE 100 share also now has a strong balance sheet that could help support dividends. Robust free cash flow saw net cash more than double in the 12 months to June, to £1.1bn.
Underlining its financial strength, Rolls is on course to repurchase £1bn of its shares in 2025.
Are Rolls shares a buy?
Rolls-Royce’s performance keeps exceeding even the most optimistic analyst forecasts. In the first half, underlying operating profit surged 50%, well above the widely predicted 10%. Sales grew by double-digit percentages at Civil Aerospace and Power Systems, while extensive streamlining also continued to pay off.
All this bodes well for dividends over the short-to-medium term. But the possibility of stunning dividend growth doesn’t necessarily make Rolls-Royce shares a Buy in my book.
Its share price is up a whopping 111% over the last year. And so the company trades on a forward price-to-earnings (P/E) ratio of 43.5 times, which reflects the possibility of further forecast-beating results.
The danger is that anything other than more blowout numbers could result in a share price correction. And with the business struggling to grow Defence revenues, and its high-performing Civil Aerospace unit vulnerable to signs of weakness in the airline industry, this is a real possibility in my book.
On balance, I’d rather buy other shares for passive income today.
