The ability to calculate the reliability of dividends is absolutely crucial for investors, not only for evaluating the income generated from your portfolio, but also to avoid a share-price collapse from stocks where payouts are slashed.
There are a variety of ways to judge future dividends, and today I am looking at Lloyds Banking Group (LSE: LLOY) (NYSE: LYG.US) to see whether the firm looks a safe bet to produce dependable payouts.
Forward dividend cover
Forward dividend cover is one of the most simple ways to evaluate future payouts, as the ratio reveals how many times the projected dividend per share is covered by earnings per share. It can be calculated using the following formula:
Forward earnings per share ÷ forward dividend per share
Lloyds is expected by City analysts to produce its first dividend in 2013 following its part-nationalisation, carried out in the aftermath of the 2008/2009 financial crisis. A payout of 0.4p is anticipated this year, with earnings per share for this year pencilled in at 4.4p. This creates dividend cover of 11, comfortably above the broadly-regarded security watermark of 2 times potential earnings.
Free cash flow
Free cash flow is essentially how much cash has been generated after all costs and can often differ from reported profits. Theoretically, a company generating shedloads of cash is in a better position to reward stakeholders with plump dividends. The figure can be calculated by the following calculation:
Operating profit + depreciation & amortisation – tax – capital expenditure – working capital increase
Lloyds’ free cash flow registered at £20.1bn in 2012, down from £24.39bn in the previous year. The bank suffered from a fall in operating profit, which slipped to £18.75bn from £21.39bn, while tax movements also caused the reading to deteriorate — Lloyds reported a tax cost of £773m in 2012, versus a credit of £828m in 2011.
This ratio is used to gauge the level debt a company carries. Simply put, the higher the amount, the more difficult it may be to generate lucrative dividends for shareholders. It can be calculated using the following calculation:
Short- and long-term debts + pension liabilities – cash & cash equivalents
___________________________________________________________ x 100
The bank reported a negative gearing ratio of 229% in 2012, an improvement from 2011’s negative reading of 186.2%. A sizeable increase in cash and cash equivalents, to £101.06bn from £85.89bn, was the major driver behind the improvement in the ratio.
Buybacks and other spare cash
Lloyds is committed to stripping out costs and spinning off non-core operations as it continues to rebuild its previously bombed-out balance sheet. The bank has previously said that it aims to cut around £9.8bn in costs this year, and to achieve a non-core asset portfolio of no more than £70 billion. Indeed, the firm sold off its International Private Banking operations just a couple of months ago.
However, like a handful of other UK banks, investors should be wary of the need for Lloyds to raise its capital reserves in line with regulatory demands. The Prudential Regulatory Authority noted in June that the institution needed to raise an additional £8.6bn to meet its requirements, although the bank said later that its restructuring plans have since reduced this sum considerably.
Not a lucrative dividend depositor
At the current time I do not believe that Lloyds offers a compelling investment case for dividend investors. The bank is only expected to offer a yield of 0.5% in 2013, far below the forward FTSE 100 average of 3.3%. And the potential sale of the government’s 40% stake in the bank makes the extent, and indeed timing, of any dividend payments a point of much contention.
As well, with the company’s transformation plan still having much more ground to cover, I believe that dividend plays with far better security and rewards can be sought out elsewhere.
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> Royston does not own shares in Lloyds Banking Group.