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 RSA Insurance Group (LSE: RSA) (NASDAQOTH: RSANY.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 brokers expect RSA Insurance Group to produce a dividend of 6.4p per share in 2013, while earnings per share during this period are put at 11.8p. This produces dividend cover of 1.8 times prospective earnings, below the generally considered safety 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
RSA reported free cash flow of £624m in 2012, an improvement from a reading of £523m in the previous year. Although operating profit dipped to £684m last year from £727m, lower capex costs combined with a reduced tax bill — this fell to £128m from £186m — helped boost cash flow.
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
RSA saw its gearing ratio register at 22.8% last year, up from 19.6% in the previous 12-month period. Most notably, pension liabilities rose to £1.89bn from £1.7bn, which offset a rise in cash and cash equivalents to £1.33bn from £1.26bn. A slight decline in shareholders’ funds — to £3.75bn from £3.8bn — also caused the ratio to rise.
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.
The company has seen business in Canada receive a leg-up following the purchase of L’Union Canadienne last year, with the acquisition of El Comercio and ACG also boosting activity in Argentina. And investors can expect further M&A activity this year after RSA confirmed its intention to generate growth ‘both organically and through selective bolt-on acquisitions‘ in May’s interims.
On the right track but near-term dividends questionable
RSA Insurance Group currently provides a dividend yield of 5% for 2013, far ahead of the 3.3% prospective average for the FTSE 100. In line with its dividend rebasement strategy, the company slashed last year’s full-year dividend to 7.31p from 9.16p in 2011 in a bid to generate long-term growth.
And although RSA has reported decent business activity in recent months, driven by emerging markets and Canada, the prospect of slowdown in these areas — coupled with ongoing stagnation in its core markets, especially the UK — could once again put dividend prospects under the spotlight.
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> Royston does not own shares in RSA Insurance Group.