Should I Invest in Marks & Spencer?

LONDON -- To me, capital growth and dividend income are equally important. Together, they provide the total return from any share investment, and, as you might expect, my aim is to invest in companies that can beat the total return delivered by the wider market.

To put that aim into perspective, the FTSE 100 has provided investors with a total return of about 3% per annum since January 2008.

Quality and value
If my investments are to outperform, I need to back companies that score well on several quality indicators and buy at prices that offer decent value. So this series aims to identify appealing FTSE 100 investment opportunities, and today I'm looking at Marks & Spencer Group (MKS -1.94%), which has a chain of high-street clothing and food retail stores in Britain and overseas.

With the shares at 387 pence, Marks and Spencer's market cap. is 6.2 billion pounds.

This table summarizes the firm's recent financial record:

The table shows a flat financial performance over the period and tells the story of the challenges facing traditional retailers these days. Against a background of structural change in the industry, with consumers shifting to non-high-street shopping, Marks & Spencer has also had to cope with the recent economic slowdown, which has customers often trapped between falling incomes and a rising cost of living. Under such pressures, it's natural for people to axe luxuries such as posh food and new undies from domestic budgets.

The firm is fighting back, though, and it plans to "transform Marks & Spencer from a traditional U.K. retailer to an international multi-channel retailer." That's a laudable goal, but a lot of work remains. Last year, although growing at an 18% clip, multichannel revenue accounted for about 6% of overall sales.

There are about 700 U.K. stores and what the company describes as an expanding international business, all of which employs some 78,000 people. The U.K. accounts for about 84% of operating profit, with the remaining 16% coming from international sales. The sales mix is something like 47% food and 53% general merchandise.

I think Marks and Spencer's total-return potential is uncertain. If it can expand its multichannel operation, it could offset what seems like the effects of an otherwise weakening business model. However, I can't help thinking that overall, the table for the next five years' finances might end up looking similar to the one shown here -- if we are lucky!

Marks & Spencer's total-return potential
Let's examine five indicators to help judge the quality of the company's total-return potential:

1. Dividend cover: Adjusted earnings covered last year's earnings just more than twice. Score: 4/5

2. Borrowings: Net gearing of 115% with net borrowings almost four times earnings. Score: 2/5

3. Growth: All of revenue, earnings, and cash flow have been flat. Score: 3/5

4. Price to earnings: A forward 11 looks fair compared to growth and yield forecasts. Score: 3/5

5. Outlook: Recent trading is mixed, and the outlook is cautious. Score: 2/5

Overall, I score Marks & Spencer 14 out of 25, which makes me cautious about the firm's potential to outpace the wider market's total return going forward.

Foolish summary
Although dividend cover is satisfactory, the firm has a lot of debt, which could cause difficulties if the decline in high-street sales accelerates. Financial performance has been flat, and the outlook is cautious. I think Marks & Spencer's valuation reflects its prospects.

Forecasters expect the company to yield about 4.7% next year, which seems attractive. But how fast can that dividend payment grow? As an alternative, I'm with The Motley Fool's top value investor, who has discovered what he believes is the best income-generating share for 2013. He sets out his three-point investing thesis in a report called "The Motley Fool's Top Income Share For 2013," which I recommend you download now. For a limited time, the report is free so, to download it immediately and discover the identity of this dividend-generating star, click here.