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Is American Campus Communities, Inc. (NYSE:ACC) A Smart Pick For Income Investors?

Simply Wall St

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Is American Campus Communities, Inc. (NYSE:ACC) a good dividend stock? How would you know? Dividend paying companies with growing earnings can be highly rewarding in the long term. Unfortunately, it's common for investors to be enticed in by the seemingly attractive yield, and lose money when the company has to cut its dividend payments.

In this case, American Campus Communities likely looks attractive to investors, given its 4.1% dividend yield and a payment history of over ten years. We'd guess that plenty of investors have purchased it for the income. 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.

Explore this interactive chart for our latest analysis on American Campus Communities!

NYSE:ACC Historical Dividend Yield, May 13th 2019

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. 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 Campus Communities paid out 75% of its profit as dividends. Paying out a majority of its earnings limits the amount that can be reinvested in the business. This may indicate a commitment to paying a dividend, or a dearth of investment opportunities.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. The company paid out 72%, which is not bad per se, but does start to limit the amount of cash American Campus Communities has available to meet other needs.

It is worth considering that American Campus Communities is a Real Estate Investment Trust (REIT). REITs have different rules governing their payments, and are often required to pay out a high portion of their earnings to investors.


Is American Campus Communities's Balance Sheet Risky?

As American Campus Communities has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. A quick way to check a company's financial situation uses these 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 on debt. Essentially we check that a) a company does not have too much debt, and b) that it can afford to pay the interest. American Campus Communities has net debt of 7.43 times its earnings before interest, tax, depreciation and amortisation (EBITDA) which implies meaningful risk if interest rates rise of earnings decline.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Interest cover of less than 5x its interest expense is starting to become a concern for American Campus Communities, and be aware that lenders may place additional restrictions on the company as well. Low interest cover and high debt can create problems right when the investor least needs them. We're generally reluctant to rely on the dividend of companies with these traits.

We update our data on American Campus Communities every 24 hours, so you can always get our latest analysis of its financial health, here.

Dividend Volatility

Before buying a stock for its income, we want to see if the dividends have been stable in the past, and if the company has a track record of maintaining its dividend. American Campus Communities has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. During this period the dividend has been stable, which could imply the business could have relatively consistent earnings power. During the past ten-year period, the first annual payment was US$1.35 in 2009, compared to US$1.88 last year. This works out to be a compound annual growth rate (CAGR) of approximately 3.4% a year over that time.


Dividend Growth Potential

Dividend payments have been consistent over the past few years, but we should always check if earnings per share (EPS) are growing, as this will help maintain the purchasing power of the dividend. 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 Campus Communities has grown its earnings per share at 16% per annum over the past five years. Earnings per share are growing nicely, but the company is paying out most of its earnings as dividends. This might be sustainable, but we wonder why American Campus Communities is not retaining those earnings to reinvest in growth.

Conclusion

To summarise, shareholders should always check that American Campus Communities's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. American Campus Communities's is paying out more than half its income as dividends, but at least the dividend is covered both by reported earnings and cashflow. That said, we were glad to see it growing earnings and paying a fairly consistent dividend. American Campus Communities 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.

Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 6 analysts we track are forecasting for American Campus Communities for free with public 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 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.