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 Vodafone (LSE: VOD) (NASDAQ: VOD.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
Vodafone is expected by City analysts to produce a dividend of 10.3p per share in the year ending March 2014, while earnings per share are forecast at 16.1p. This results in dividend cover of 1.6 times prospective earnings, below the generally-regarded benchmark 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
Vodafone saw free cash flow fall to £3.42bn in 2013 from £9.93bn in the previous 12-month period. This was mainly attributable to a massive decline in operating profit, to £4.73bn from £11.19bn. Depreciation and amortisation and tax remained broadly similar, although capex fell slightly to £6.27bn from £6.37bn. The working capital increase was also at £318m last year versus £206m in 2012.
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
Vodafone saw its gearing ratio register at 44.7% last year, up from 38.9% in 2012. Long and short term debt rose markedly to £41.4bn in 2013, up from £34.6bn, while pension liabilities also rose to £629m from £337m. As the gearing ratio increased even though shareholders’ equity rose to £76.94bn from £71.48bn.
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.
Vodafone has been extremely active on the buyback front. After selling its holding in SFR to Vivendi in June 2011, the company launched a £4bn buyback scheme which completed last August. This has been followed by another £1.5bn programme after joint venture Verizon Wireless declared an $8.5bn dividend in November.
The mobile giant said that it expects capital expenditure “to remain broadly steady” moving forwards. Indeed, the firm announced last month that it intends to purchase Kabel Deutschland for £6.6bn. The move enables Vodafone to gain entry to Germany’s lucrative ‘quad play’ telecoms services sector covering the television, broadband, and mobile and fixed-line telephone areas.
The deal has again raised speculation over the future of Vodafone’s stake in Verizon Wireless, too — rumours have been circulating for some time that the company could sell its holding to Verizon Communications, while a full takeover of Vodafone by the firm has also been rumoured. Any sale of Vodafone’s stake in Verizon Wireless would significantly boost its cash position.
Dial in for strong dividends
I reckon that Vodafone is a decent pick for those seeking strong, reliable dividends. In my opinion both free cash flow and gearing are running at levels which do not put dividend potential under stress, and I believe the company is primed for strong growth and thus decent dividend expansion.
Vodafone is tipped to provide a dividend yield of 5.4% in 2014, well above the 3.3% FTSE 100 average. The company has steadily lifted the full-year dividend for a number of years, and with earnings expected to continue treading higher at least for the medium term, I fully expect this trend to continue.
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> Royston does not own shares in any company mentioned. The Motley Fool has recommended shares in Vodafone.