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Dividend paying stocks like American Assets Trust, Inc. (NYSE:AAT) 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 2.3% yield and a eight-year payment history, investors probably think American Assets Trust looks like a reliable dividend stock. A 2.3% yield is not inspiring, but the longer payment history has some appeal. There are a few simple ways to reduce the risks of buying American Assets Trust for its dividend, and we'll go through these below.
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, American Assets Trust paid out 38% of its profit as dividends. A medium payout ratio strikes a good balance between paying dividends, and keeping enough back to invest in the business. One of the risks is that management reinvests the retained capital poorly instead of paying a higher dividend.
Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. American Assets Trust paid out 81% of its cash flow last year. This may be sustainable but it does not leave much of a buffer for unexpected circumstances. It's positive to see that American Assets Trust's dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.
REITs like American Assets Trust often have different rules governing their distributions, so a higher payout ratio on its own is not unusual.
Is American Assets Trust's Balance Sheet Risky?
As American Assets Trust has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. 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. With net debt of 6.65 times its EBITDA, American Assets Trust could be described as a highly leveraged company. While some companies can handle this level of leverage, we'd be concerned about the dividend sustainability if there was any risk of an earnings downturn.
Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. With EBIT of 1.85 times its interest expense, American Assets 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.
Remember, you can always get a snapshot of American Assets Trust's latest financial position, by checking our visualisation of its financial health.
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 American Assets Trust paid its first dividend at least eight years ago. During the past eight-year period, the first annual payment was US$0.84 in 2011, compared to US$1.12 last year. This works out to be a compound annual growth rate (CAGR) of approximately 3.7% 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
Examining whether the dividend is affordable and stable is important. However, it's also important to assess if earnings per share (EPS) are growing. Over the long term, dividends need to grow at or above the rate of inflation, in order to maintain the recipient's purchasing power. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see American Assets Trust has grown its earnings per share at 12% per annum over the past five years. A company paying out less than a quarter of its earnings as dividends, and growing earnings at more than 10% per annum, looks to be right in the cusp of its growth phase. At the right price, we might be interested.
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. American Assets Trust's dividend payout ratios are within normal bounds, although we note its cash flow is not as strong as the income statement would suggest. Next, earnings growth has been good, but unfortunately the company has not been paying dividends as long as we'd like. American Assets Trust has a number of positive attributes, but it falls slightly short of our (admittedly high) standards. Were there evidence of a strong moat or an attractive valuation, it could still be well worth a look.
Earnings growth generally bodes well for the future value of company dividend payments. See if the 4 American Assets Trust analysts we track are forecasting continued growth with our free report on analyst estimates for the company.
Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield above 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 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. Thank you for reading.