Should I Invest in Rolls-Royce Holdings

LONDON -- To me, capital growth and dividend income are equally important. Together, they provide the total return from any share investment and, as you might expect, my aim is to invest in companies that can beat the total return delivered by the wider market.

To put that aim into perspective, the FTSE 100 has provided investors with a total return of around 3% per annum since January 2008.

Quality and value
If my investments are to outperform, I need to back companies that score well on several quality indicators and buy at prices that offer decent value.

So this series aims to identify appealing FTSE 100 investment opportunities and today I'm looking at Rolls-Royce Holdings  (LSE: RR  ) , the integrated power systems and services provider operating internationally in the aerospace, marine and energy markets.

With the shares at 1213 pence, Rolls-Royce's market cap. is £22,826 million.

This table summarises the firm's recent financial record:

Year to December 2008 2009 2010 2011 2012
Revenue (£m) 9,082 10,414 11,085 11,124 12,161
Net cash from operations (£m) 1,015 859 1,340 1,306 1,255
Adjusted earnings per share 36.7p 39.67p 38.73p 48.54p 59.27p
Dividend per share 14.3p 15p 16p 17.5p 19.5p

The Trent family of engines is proving to be a big seller for Rolls-Royce with recent orders coming in from Europe and America to power Airbus aircraft. The firm's constant investment in research and development, some £919 million last year, has ensured the Trent brand delivers high fuel and operating efficiency; both are quality features that keep the engine at the top of customer shopping lists around the world.

As well as success in the civil aviation market, Rolls-Royce has recently signed several contracts to provide and service military transport engines for the U.S. Air Force and U.S. Marine Corps, and started work on a new facility in Derby that will produce reactor cores for U.K. submarines.

With an order book standing at about £60 billion, the firm looks poised to perform well on total returns from here as its technology continues to hit the spot in the markets it serves.

Rolls-Royce's total-return potential
Let's examine five indicators to help judge the quality of the company's total-return potential:

  1. Dividend cover: adjusted earnings covered last year's dividend over three times. 5/5
  2. Borrowings: At the last count, there was net cash on the balance sheet. 5/5
  3. Growth: growing revenue and earnings with solid cash flow support. 5/5
  4. Price to earnings: a forward 17 or so looks ahead of growth and yield expectations. 2/5
  5. Outlook: satisfactory recent trading and a cautiously positive outlook. 4/5

Overall, I score Rolls-Royce 21 out of 25, which encourages me to believe the firm has potential to outpace the wider market's total return, despite the high-looking valuation.

Foolish summary
The rich valuation recognizes a strong showing on the business-quality metrics. Although the outlook is good, I'm cautious about buying the shares right now.

One thing that puts me off Rolls-Royce is the relatively low dividend yield, a forward 2%, or so. Yield is an important component of total returns, and I'm excited about an idea the Motley Fool's top value investor believes is the best income generating share-play for 2013. He set's out his three-point investing thesis in a report called "The Motley Fool's Top Income Share for 2013", which I recommend you download now. For a limited time, the report is free so, to download it immediately, and discover the identity of this dividend-generating star, click here.

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