Where Next for Barclays' Dividend?

Many investors focus on earnings per share when judging a company's performance. However, earnings can be manipulated and adjusted in all sorts of ways, meaning they don't tell you a lot about how much spare cash a company has generated. Similarly, since dividend cover is calculated using earnings, a good level of dividend cover doesn't necessarily mean the payout is actually being funded from a company's profits.

A company's cash flow can tell you a lot about a firm's financial health. Is the company burning up its cash reserves on interest payments and operating expenses, or does it generate spare cash with which it can fund dividends or retain for future investment? If a dividend isn't funded by cash flow, then there is a greater chance the payout will become unaffordable and be cut, which is bad news for shareholders like you and me.

In this series, I'm going to take a look at the cash flow statements of some of the biggest names in the FTSE 100 (UKX) to see whether their dividends are being funded in a sustainable way, from genuine spare cash. Today, I'm looking at Barclays .

Does Barclays have enough cash?
As private investors, we want to back businesses that are able to pay their dividends out of free cash flow each year. I define free cash flow as the cash that's left over after capital expenditure, interest payments and tax deductions. With that in mind, let's look at Barclays' cash flow from the last five years:

Source: Barclays annual reports. *A value of >1 means the dividend was covered by free cash flow.

The figures above appear to suggest that Barclays has been generating massive amounts of free cash flow. However, all is not quite as it seems, and much of this cash has been spoken for. Like RBS and Lloyds, Barclays has been working hard since 2008 to improve its ability to deal with future financial shocks and bad debt. This ability is measured using a bank's core tier one capital and its core tier one ratio. Core tier one capital is essentially the amount of cash a bank has, while the core tier one ratio compares the amount of core tier one capital to the bank's risk-weighted assets (its loan book). By increasing core tier one capital and reducing its loan book, Barclays has been able to improve its core tier one ratio to its current value of 11%.

However, achieving this result has meant hoarding cash ferociously -- something all of the major U.K. banks have been doing. This has attracted criticism from politicians and the public, who bemoan the banks' reluctance to lend, but the effect it has had on Barclays' finances is clear. Barclays' balance of cash and cash equivalents has risen from a mere 20 billion pounds at the end of 2005 to a mighty 149 billion pounds at the end of 2011. Set against this, it's easy to see why the major banks' share prices have not been affected by LIBOR, PPI and other scandals -- the amounts of money involved in paying the fines are simply too small to worry about. The 1 billion pounds set aside by Barclays to handle PPI claims is a substantial amount of money -- but it is hardly likely to trouble a bank that generated 27 billion pounds of free cash flow in 2011.

Is Barclays' dividend safe?
In 2008, Barclays avoided the humiliation of a government bailout by securing a major injection of funds from Qatar's sovereign wealth fund, Qatar Holdings. That deal also enabled Barclays to avoid the EU ban on paying dividends -- recipients of state aid such as RBS and Lloyds were banned from making shareholder payouts until April 2012. The end result is that Barclays -- rightly or wrongly -- appeared to have survived the credit crunch more successfully than its U.K.-focused peers, and was never forced to cancel its dividend.

Of course, it wasn't all plain sailing. Barclays paid out 34 pence per share in 2007. In 2008, this was slashed to 11.5 pence, and in 2009 the bank's dividend payout hit a record low of 2.5 pence per share. Things have improved since then and the dividend was back up to 6 pence in 2011. This year's total payout is expected to be 6.4 pence, a 6.3% increase. So what are the dividend prospects for Barclays' long-suffering shareholders?

If you've held Barclays' shares since before the financial crisis, your yield on cost will be pretty low, a situation that is likely to persist for some time. However, I think that Barclays' dividend is pretty safe at its current levels and is likely to continue to grow over the next two or three years.

Top income tips
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Woodford selects stocks that he believes are undervalued and likely to deliver strong dividend growth. His record is one of the best in the City (he sold his banking shares before the crash) and at the end of October 2012, he had 21 billion pounds of private investors' funds under management -- more than any other City fund manager.

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The article Where Next for Barclays' Dividend? originally appeared on Fool.com.

Roland does not own shares in any of the companies mentioned in this article. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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