Investors In The Unite Group plc (LON:UTG) Should Consider This, First

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Dividend paying stocks like The Unite Group plc (LON:UTG) tend to be popular with investors, and for good reason - some research suggests a significant amount of all stock market returns come from reinvested dividends. If you are hoping to live on the income from dividends, it's important to be a lot more stringent with your investments than the average punter.

A slim 2.8% yield is hard to get excited about, but the long payment history is respectable. At the right price, or with strong growth opportunities, Unite Group could have potential. Some simple analysis can reduce the risk of holding Unite Group for its dividend, and we'll focus on the most important aspects below.

Explore this interactive chart for our latest analysis on Unite Group!

Payout ratios

Dividends are typically paid from company earnings. If a company pays more in dividends than it earned, then the dividend might become unsustainable - hardly an ideal situation. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. In the last year, Unite Group paid out 104% of its profit as dividends. A payout ratio above 100% is definitely an item of concern, unless there are some other circumstances that would justify it.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. With a cash payout ratio of 120%, Unite Group's dividend payments are poorly covered by cash flow. As Unite Group's dividend was not well covered by either earnings or cash flow, we would be concerned that this dividend could be at risk over the long term.

REITs like Unite Group often have different rules governing their distributions, so a higher payout ratio on its own is not unusual.

Is Unite Group's Balance Sheet Risky?

As Unite Group's dividend was not well covered by earnings, we need to check its balance sheet for signs of financial distress. A quick check of its financial situation can be done with two ratios: net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and net interest cover. Net debt to EBITDA measures total debt load relative to company earnings (lower = less debt), while net interest cover measures the ability to pay interest on the debt (higher = greater ability to pay interest costs). With net debt of 4.15 times its EBITDA, investors are starting to take on a meaningful amount of risk, should the business enter a downturn.

We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. Unite Group has EBIT of 7.89 times its interest expense, which we think is adequate.

Dividend Volatility

From the perspective of an income investor who wants to earn dividends for many years, there is not much point buying a stock if its dividend is regularly cut or is not reliable. Unite Group has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. The dividend has been cut by more than 20% on at least one occasion historically. During the past ten-year period, the first annual payment was UK£0.025 in 2009, compared to UK£0.29 last year. This works out to be a compound annual growth rate (CAGR) of approximately 28% a year over that time. Unite Group's dividend payments have fluctuated, so it hasn't grown 28% every year, but the CAGR is a useful rule of thumb for approximating the historical growth.

Unite Group has grown distributions at a rapid rate despite cutting the dividend at least once in the past. Companies that cut once often cut again, but it might be worth considering if the business has turned a corner.

Dividend Growth Potential

Given that the dividend has been cut in the past, we need to check if earnings are growing and if that might lead to stronger dividends in the future. It's good to see Unite Group has been growing its earnings per share at 15% a year over the past 5 years. While EPS are growing rapidly, Unite Group paid out a very high 104% of its income as dividends. If earnings continue to grow, this dividend may be sustainable, but we think a payout this high definitely bears watching.

We'd also point out that Unite Group issued a meaningful number of new shares in the past year. Trying to grow the dividend when issuing new shares reminds us of the ancient Greek tale of Sisyphus - perpetually pushing a boulder uphill. Companies that consistently issue new shares are often suboptimal from a dividend perspective.

Conclusion

When we look at a dividend stock, we need to form a judgement on whether the dividend will grow, if the company is able to maintain it in a wide range of economic circumstances, and if the dividend payout is sustainable. Unite Group paid out almost all of its cash flow and profit as dividends, leaving little to reinvest in the business. Next, earnings growth has been good, but unfortunately the dividend has been cut at least once in the past. In summary, Unite Group has a number of shortcomings that we'd find it hard to get past. Things could change, but we think there are likely more attractive alternatives out there.

See if management have their own wealth at stake, by checking insider shareholdings in Unite Group stock.

We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 3%.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.