Today we'll take a closer look at Preferred Apartment Communities, Inc. (NYSE:APTS) from a dividend investor's perspective. Owning a strong business and reinvesting the dividends is widely seen as an attractive way of growing your wealth. Yet sometimes, investors buy a stock for its dividend and lose money because the share price falls by more than they earned in dividend payments.
With a goodly-sized dividend yield despite a relatively short payment history, investors might be wondering if Preferred Apartment Communities is a new dividend aristocrat in the making. It sure looks interesting on these metrics - but there's always more to the story . Some simple research can reduce the risk of buying Preferred Apartment Communities for its dividend - read on to learn more.
Explore this interactive chart for our latest analysis on Preferred Apartment Communities!
Payout ratios
Dividends are usually paid out of company earnings. If a company is paying more than it earns, then the dividend might become unsustainable - hardly an ideal situation. As a result, we should always investigate whether a company can afford its dividend, measured as a percentage of a company's net income after tax. While Preferred Apartment Communities pays a dividend, it reported a loss over the last year. Unless there are extenuating circumstances, from the perspective of an investor who hopes to own the company for many years, a payout ratio of above 100% is definitely a concern.
Preferred Apartment Communities paid out 95% of its cash flow last year. This may be sustainable but it does not leave much of a buffer for unexpected circumstances.
REITs like Preferred Apartment Communities often have different rules governing their distributions, so a higher payout ratio on its own is not unusual.
Is Preferred Apartment Communities's Balance Sheet Risky?
As Preferred Apartment Communities'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 is a measure of a company's total debt. Net interest cover measures the ability to meet interest payments. Essentially we check that a) the company does not have too much debt, and b) that it can afford to pay the interest. Preferred Apartment Communities has net debt of 11.23 times its EBITDA, which we think carries substantial risk if earnings aren't sustainable.
We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. Preferred Apartment Communities has interest cover of less than 1 - which suggests its earnings are not high enough to cover even the interest payments on its debt. This is potentially quite serious, and we would likely avoid the stock if it were not resolved quickly. Low interest cover and high debt can create problems right when the investor least needs them, and we're reluctant to rely on the dividend of companies with these traits. That said, Preferred Apartment Communities is in the real estate business, which is typically able to sustain much higher levels of debt, relative to other industries.
Dividend Volatility
One of the major risks of relying on dividend income, is the potential for a company to struggle financially and cut its dividend. Not only is your income cut, but the value of your investment declines as well - nasty. Looking at the last decade of data, we can see that Preferred Apartment Communities paid its first dividend at least eight years ago. The dividend has been quite stable over the past eight years, which is great to see - although we usually like to see the dividend maintained for a decade before giving it full marks, though. During the past eight-year period, the first annual payment was US$0.50 in 2011, compared to US$1.05 last year. This works out to be a compound annual growth rate (CAGR) of approximately 9.7% a year over that time.
Preferred Apartment Communities has been growing its dividend at a decent rate, and the payments have been stable despite the short payment history. This is a positive start.
Dividend Growth Potential
While dividend payments have been relatively reliable, it would also be nice if earnings per share (EPS) were growing, as this is essential to maintaining the dividend's purchasing power over the long term. Preferred Apartment Communities's earnings per share have shrunk at 25% a year over the past five years. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and Preferred Apartment Communities's earnings per share, which support the dividend, have been anything but stable.
We'd also point out that Preferred Apartment Communities 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. We're not keen on the fact that Preferred Apartment Communities paid dividends despite reporting a loss over the past year, although fortunately its dividend was covered by cash flow. Earnings per share have been falling, and the company has a relatively short dividend history - shorter than we like, anyway. Using these criteria, Preferred Apartment Communities looks quite suboptimal from a dividend investment perspective.
Without at least some growth in earnings per share over time, the dividend will eventually come under pressure either from costs or inflation. Very few businesses see earnings consistently shrink year after year in perpetuity though, and so it might be worth seeing what the 3 analysts we track are forecasting for the future.
Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield above 3%.
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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.