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 Barclays (LSE: BARC) (NYSE: BCS.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
City analysts expect the bank to produce a dividend of 7.2p per share in 2013. With earnings per share of 34.8p forecast for this period, dividend cover registers at 4.8 times prospective earnings, smashing the safety 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
Barclays saw free cash flow register at £14.74bn last year, down considerably from £21.04bn in 2011. Operating revenue dropped to £21.1bn from £26.7bn, pushing operating profit to just £106m in 2012 versus £5.91bn in 2011. Capital expenditure increased to £7.1bn from £1.91bn, while less favourable working capital flows also weighed on cash movements last year.
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
Encouragingly, Barclays punched a negative gearing ratio of 193.2% in 2012, although down from the negative readout of 229.1% seen in the previous year. Cash and cash equivalents dropped to £121.91bn from £149.67bn. And a decline in shareholders’ equity, to £62.96bn from £65.2bn, exacerbated the drop.
Buybacks and other spare cash
The company has imposed stringent cost-cutting measures and restructuring to plans following the 2008/2009 financial crisis, which battered the company’s balance sheet. Still, the bank still has heavy work to do to meet the capital requirements of industry regulators.
In June, Barclays was warned by the newly created Prudential Regulation Authority that it faced a £3bn shortfall in its capital pile — banks are required under tier 1 capital requirements to hold reserves of at least 7% of their risk-weighted assets. With the bank already expected to create £1.3bn of additional capital by the end of December, that leaves a £1.7bn hole to be filled.
Don’t bank on bumper dividends
Barclays’ ongoing transformation strategy, combined with promising momentum at its Barclays Capital investment division and Barclaycard divisions, is resurrecting the bank’s financial strength and with it undergirding future dividend potential.
However, payout prospects in the meantime remain decidedly under par as the company rebuilds for the future. Forecasters expect Barclays to provide a dividend yield of 2.3% in 2013, far below the 3.3% FTSE 100 average. Given that ongoing regulatory issues could also strain future dividend potential, I believe that more attractive income picks can be attained elsewhere.
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Woodford — head of UK Equities at Invesco Perpetual — has more than 30 years’ experience in the industry, and boasts an exceptional track record when it comes to selecting stock market stars.
> Royston does not own shares in Barclays.