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 SSE (LSE: SSE) 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
SSE is expected to provide a dividend of 87.8p in the year ending March 2014, according to City brokers. Meanwhile, earnings per share are pencilled in at 117.3p for this period, providing dividend cover of 1.3 times forward earnings. This is well below the widely regarded security threshold of 2 times.
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
SSE registered positive free cash flow of £542.6m in the year ending March 2013, an improvement from the negative reading of £277.3m in the previous 12-month period. Operating profit advanced to £1.78bn from £1.66bn in 2012, while lower capital expenditure — at £1.49bn versus £1.71bn previously — also helped boost cash. Furthermore, a smaller working capital increase, of £108m in 2013 against £590m the prior year, improved capital flows.
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
SSE’s gearing ratio came in at 125.2% last year, down from 146.9% in 2012. Total debt rose to £6.95bn from £6.37bn the previous year, although cash and cash equivalents rose to £539m from £189 in 2012. Pension liabilities remained stable. Instead, a major hike in shareholder equity — to £5.55bn from £4.58bn — was responsible for the gearing decrease.
Buybacks and other spare cash
Here, I’m looking at the amount of cash recently spent on share buybacks, repayments of debt and other activities that suggest the company may in future have more cash to spend on dividends.
SSE has spent in the region of £4.6bn over the past three years in order to expand its asset base and charge future earnings, including significant investment in its electricity networks and boosting generation from its wind farm assets. The company has now committed more than £1.5bn for further investment for the current year, and has laid out a clear strategy for investment through to March 2015.
A dependable and decent payout pick
SSE affirmed in last week’s interims that full-year dividends remain on track to rise ahead of retail price inflation (RPI) for this year and beyond. The company has a solid record of lifting payouts each year since 1999, and the business currently sports a 5.5% dividend yield, comfortably ahead of the 3.3% FTSE 100 average.
The electricity play has stated that it intends to keep dividend cover around 1.5 times earnings, and although this — like those of broker forecasts — remains below the safety watermark, the firm’s operations in the defensive electricity sector help to safeguard steady earnings growth.
Combined with improving financials over the past year and continued heavy investment, I believe that the firm is well placed to keep dividends moving northwards over the long term.
Power your dividend income with the Fool
If you already hold shares in SSE, and are looking for other lucrative payout plays to really propel the income from your stock portfolio, I recommend you take a look at this exclusive, in-depth report about another FTSE 100 high-income opportunity.
The blue chip in question offers a prospective dividend yield comfortably north of 5%, and has been declared “The Motley Fool’s Top Income Stock For 2013“! Click here to download the report now — it’s absolutely free and comes with no further obligation.
> Royston owns shares in SSE.