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 Marks & Spencer (LSE: MKS) 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
City analysts expect Marks & Spencer to provide a dividend of 17.7p per share in the year ending March 2014. With earnings per share forecast at 33.4p, dividend cover comes in at 1.9 times, just below the widely-considered safety mark 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
Marks & Spencer saw free cash flow fall to £359.7m in the year ending March 2013, down from £499m in the previous year. Operating profit nudged up to £756m from £746.5m, and tax fell to £106.3m from £168.4m. But this was more than offset by higher capex, which moved to £829.7m from £720.7m, while working capital movements also affected the readout.
Financial gearing
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
Shareholder funds
The retailer saw its gearing ratio rise to 108% in 2013, up markedly from 70% in the previous year. Net debt rocketed to £2.61bn from £1.86bn in 2012. As well, a reduction in shareholder funds — to £2.49bn from £2.78bn — also prompted the ratio to jump higher.
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.
Marks & Spencer continues to plough vast capital into the business to fuel future earnings, albeit down from earlier levels. It plans to spend around £550m this year as part of a “lower, more sustainable long-term” investment programme. The firm is undertaking a huge multinational approach to revenues growth through new store openings; franchise creation; and improvement to its multi-channel sales approach, particularly in emerging markets.
Near-term weakness could harm dividend growth
Although the company’s ambitious expansion plan bodes well for long-term growth, enduring difficulties in the UK market continue to cast doubt over earnings, and thus dividend prospects, in the meantime. Like-for-like sales rose just 0.3% in the first quarter, the company said earlier this month, still weighed down by poor performance in general merchandise where sales dipped 1.6%. These issues, and company’s measures to address them, are reflected in the numbers discussed above.
Marks & Spencer is expected to boast a dividend yield of 3.8% in 2014, beating the prospective average of 3.3% for the wider FTSE 100. However, Marks & Spencer has kept the dividend on hold at 17p since 2011, and a murky earnings picture this year could put broker projections for this year in jeopardy.
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> Royston does not own shares in Marks & Spencer.
