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 HSBC Holdings (LSE: HSBA) (NYSE: HBC.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
HSBC is expected to produce a dividend of 33.8p per share in 2013, with earnings per share during this period anticipated to come in at 65.3p. This provides dividend cover of 1.9 times prospective earnings, just below 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
HSBC’s free cash flow came in at $11.86bn in 2012, a decent result but down from $14.51bn in 2011. Operating profit fell to $17.09bn from $18.61bn, while depreciation and amortisation also dropped to $2.53bn from $3.14bn. Additionally, the company’s tax bill edged higher, although falling capex costs helped lower the cash flow fall — this moved to $2.28bn from $3.14bn 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
HSBC’s gearing ratio came in at a negative reading of 177.7% in 2012, although this was down from 202.7% in 2011. Retirement liabilities edged to $3.9bn from $3.7bn, while cash and cash equivalents dropped to $315.3bn from $325.4bn.
Buybacks and other spare cash
Compared to numerous other banking plays, who are having to bolster their capital reserves in line with regulatory requirements, HSBC is in relatively good shape. Indeed, the bank currently sports a core tier 1 capital ratio of 12.7%. This is far north of the requirement to hold reserves of at least 7% of its risk-weighted assets.
Still, investors should be mindful that the company produces more than 90% of revenues from the Asia-Pacific region, and that increasing signs of economic cooling in China could weigh heavily on the firm. Liberum Capital estimates that HSBC could experience a $32bn capital deficit in the event of a ‘hard landing’.
Bank on dividend growth to keep on rolling
Still, I believe that HSBC’s pan global operations should deliver reliable earnings growth, in turn enhancing its qualities for those seeking attractive investment income. The bank has steadily rebuilt full-year payouts following the aftermath of the 2008/2009 banking crisis, and I think the firm’s balance sheet is strong enough to keep this trend in tact.
City brokers have pencilled in a dividend yield of 4.6% in 2013, far above the 3.3% prospective average for the broader FTSE 100. I believe that the bank is a great pick for those seeking both lucrative and secure dividend streams.
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> Royston does not own shares in HSBC Holdings.