Royalty Pharma plc (NASDAQ:RPRX) will pay a dividend of $0.21 on the 10th of December. This makes the dividend yield 3.0%, which will augment investor returns quite nicely.

View our latest analysis for Royalty Pharma

Royalty Pharma's Future Dividend Projections Appear Well Covered By Earnings

A big dividend yield for a few years doesn't mean much if it can't be sustained. Prior to this announcement, Royalty Pharma's dividend was only 55% of earnings, however it was paying out 124% of free cash flows. This signals that the company is more focused on returning cash flow to shareholders, but it could mean that the dividend is exposed to cuts in the future.

Over the next year, EPS is forecast to expand by 38.9%. Assuming the dividend continues along recent trends, we think the payout ratio could be 51% by next year, which is in a pretty sustainable range.

Royalty Pharma Doesn't Have A Long Payment History

The dividend hasn't seen any major cuts in the past, but the company has only been paying a dividend for 4 years, which isn't that long in the grand scheme of things. The dividend has gone from an annual total of $0.60 in 2020 to the most recent total annual payment of $0.84. This implies that the company grew its distributions at a yearly rate of about 8.8% over that duration. Royalty Pharma has been growing its dividend at a decent rate, and the payments have been stable. However, the payment history is very short, so there is no evidence yet that the dividend can be sustained over a full economic cycle.

Dividend Growth Potential Is Shaky

Investors who have held shares in the company for the past few years will be happy with the dividend income they have received. Unfortunately things aren't as good as they seem. Royalty Pharma's earnings per share has shrunk at 15% a year over the past three years. A sharp decline in earnings per share is not great from from a dividend perspective. Even conservative payout ratios can come under pressure if earnings fall far enough. However, the next year is actually looking up, with earnings set to rise. We would just wait until it becomes a pattern before getting too excited.

The Dividend Could Prove To Be Unreliable

Overall, it's nice to see a consistent dividend payment, but we think that longer term, the current level of payment might be unsustainable. While the low payout ratio is a redeeming feature, this is offset by the minimal cash to cover the payments. We would be a touch cautious of relying on this stock primarily for the dividend income.