One Metric To Rule Them All: Gladstone Commercial Corporation (NASDAQ:GOOD)

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Gladstone Commercial Corporation is a US$660m small-cap, real estate investment trust (REIT) based in McLean, United States. REITs own and operate income-generating property and adhere to a different set of regulations. This impacts how GOOD’s business operates and also how we should analyse its stock. Below, I’ll look at a few important metrics to keep in mind as part of your research on GOOD.

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A common financial term REIT investors should know is Funds from Operations, or FFO for short, which is a REIT’s main source of income from its portfolio of property, such as rent. FFO is a cleaner and more representative figure of how much GOOD actually makes from its day-to-day operations, compared to net income, which can be affected by one-off activities or non-cash items such as depreciation. For GOOD, its FFO of US$56m makes up 62% of its gross profit, which means the majority of its earnings are high-quality and recurring.

NasdaqGS:GOOD Historical Debt, July 5th 2019
NasdaqGS:GOOD Historical Debt, July 5th 2019

In order to understand whether GOOD has a healthy balance sheet, we have to look at a metric called FFO-to-total debt. This tells us how long it will take GOOD to pay off its debt using its income from its main business activities, and gives us an insight into GOOD’s ability to service its borrowings. With a ratio of 9.8%, the credit rating agency Standard & Poor would consider this as aggressive risk. This would take GOOD 10 years to pay off using just operating income, which is a long time, and risk increases with time. But realistically, companies have many levers to pull in order to pay back their debt, beyond operating income alone.

Next, interest coverage ratio shows how many times GOOD’s earnings can cover its annual interest payments. Usually the ratio is calculated using EBIT, but for REITs, it’s better to use FFO divided by net interest. This is similar to the above concept, but looks at the nearer-term obligations. With an interest coverage ratio of 2.12x, GOOD is not generating an appropriate amount of cash from its borrowings. Typically, a ratio of greater than 3x is seen as safe.

In terms of valuing GOOD, FFO can also be used as a form of relative valuation. Instead of the P/E ratio, P/FFO is used instead, which is very common for REIT stocks. In GOOD’s case its P/FFO is 11.88x, compared to the long-term industry average of 16.5x, meaning that it is undervalued.

Next Steps:

In this article, I’ve taken a look at Funds from Operations using various metrics, but it is certainly not sufficient to derive an investment decision based on this value alone. Gladstone Commercial can bring about diversification for your portfolio, but before you decide to invest, take a look at the other aspects you must consider before investing:

  1. Future Outlook: What are well-informed industry analysts predicting for GOOD’s future growth? Take a look at our free research report of analyst consensus for GOOD’s outlook.
  2. Valuation: What is GOOD worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether GOOD is currently mispriced by the market.
  3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

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.