Dividend paying stocks like Independence Realty Trust, Inc. (NYSE:IRT) 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. On the other hand, investors have been known to buy a stock because of its yield, and then lose money if the company’s dividend doesn’t live up to expectations.
With a six-year payment history and a 4.9% yield, many investors probably find Independence Realty Trust intriguing. We’d agree the yield does look enticing. Before you buy any stock for its dividend however, you should always remember Warren Buffett’s two rules: 1) Don’t lose money, and 2) Remember rule #1. We’ll run through some checks below to help with this.
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. Comparing dividend payments to a company’s net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Looking at the data, we can see that 116% of Independence Realty Trust’s profits were paid out as dividends in the last 12 months. 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.
Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Independence Realty Trust paid out 261% of its free cash flow last year, suggesting the dividend is poorly covered by cash flow. Paying out such a high percentage of cash flow suggests that the dividend was funded from either cash at bank or by borrowing, neither of which is desirable over the long term. Cash is slightly more important than profit from a dividend perspective, but given Independence Realty Trust’s payments were not well covered by either earnings or cash flow, we are concerned about the sustainability of this dividend.
Independence Realty Trust is a REIT, which is an investment structure that often has different payout rules compared to other companies. It is not uncommon for REITs to pay out 100% of their earnings each year.
Is Independence Realty Trust’s Balance Sheet Risky?
As Independence Realty Trust’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). Independence Realty Trust has net debt of 9.70 times its EBITDA, which implies meaningful risk if interest rates rise of earnings decline.
We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company’s net interest expense. With EBIT of 1.30 times its interest expense, Independence Realty Trust’s interest cover is starting to look a bit thin. 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, Independence Realty Trust is in the real estate business, which is typically able to sustain much higher levels of debt, relative to other industries.
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. Independence Realty Trust has been paying a dividend for the past six years. The dividend has been quite stable over the past six 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 six-year period, the first annual payment was US$0.64 in 2013, compared to US$0.72 last year. This works out to be a compound annual growth rate (CAGR) of approximately 2.0% a year over that time.
Modest dividend growth is good to see, especially with the payments being relatively stable. However, the payment history is relatively short and we wouldn’t want to rely on this dividend too much.
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. It’s good to see Independence Realty Trust has been growing its earnings per share at 29% a year over the past five years. Earnings per share have been growing very rapidly, although the company is also paying out virtually all of its profit in dividends. Generally, a company that is growing rapidly while paying out a majority of its earnings, is seeing its debt burden increase. We’d be conscious of any extra risk added by this practice.
We’d also point out that Independence Realty Trust issued a meaningful number of new shares in the past year. Regularly issuing new shares can be detrimental – it’s hard to grow dividends per share when new shares are regularly being created.
Dividend investors should always want to know if a) a company’s dividends are affordable, b) if there is a track record of consistent payments, and c) if the dividend is capable of growing. We’re a bit uncomfortable with Independence Realty Trust paying out a high percentage of both its cashflow and earnings. We were also glad to see it growing earnings, although its dividend history is not as long as we’d like. Overall, Independence Realty Trust falls short in several key areas here. Unless the investor has strong grounds for an alternative conclusion, we find it hard to get interested in a dividend stock with these characteristics.
Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 9 analysts we track are forecasting for Independence Realty Trust for free with public analyst estimates for the company.
We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 3%.
If you spot an error that warrants correction, please contact the editor at email@example.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.
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