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Is CareTrust REIT, Inc.'s (NASDAQ:CTRE) 3.8% Dividend Worth Your Time?

Simply Wall St

Is CareTrust REIT, Inc. (NASDAQ:CTRE) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. If you are hoping to live on the income from dividends, it's important to be a lot more stringent with your investments than the average punter.

In this case, CareTrust REIT likely looks attractive to dividend investors, given its 3.8% dividend yield and five-year payment history. We'd agree the yield does look enticing. Some simple research can reduce the risk of buying CareTrust REIT for its dividend - read on to learn more.

Explore this interactive chart for our latest analysis on CareTrust REIT!

NasdaqGS:CTRE Historical Dividend Yield, October 31st 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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. In the last year, CareTrust REIT paid out 70% of its profit as dividends. This is a healthy payout ratio, and while it does limit the amount of earnings that can be reinvested in the business, there is also some room to lift the payout ratio over time.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. CareTrust REIT paid out 62% of its free cash flow last year, which is acceptable, but is starting to limit the amount of earnings that can be reinvested into the business. It's encouraging to see that the dividend is covered by both profit and cash flow. This generally suggests the dividend is sustainable, as long as earnings don't drop precipitously.

CareTrust REIT 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 CareTrust REIT's Balance Sheet Risky?

As CareTrust REIT has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. A rough way to check this is with these two simple ratios: a) net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and b) 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. CareTrust REIT has net debt of 3.79 times its EBITDA, which is getting towards the limit of most investors' comfort zones. Judicious use of debt can enhance shareholder returns, but also adds to the risk if something goes awry.

We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. Interest cover of 3.38 times its interest expense is starting to become a concern for CareTrust REIT, and be aware that lenders may place additional restrictions on the company as well. That said, CareTrust REIT is in the real estate business, which is typically able to sustain much higher levels of debt, relative to other industries.

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

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. CareTrust REIT has been paying a dividend for the past five years. During the past five-year period, the first annual payment was US$0.50 in 2014, compared to US$0.90 last year. Dividends per share have grown at approximately 12% per year over this time.

We're not overly excited about the relatively short history of dividend payments, however the dividend is growing at a nice rate and we might take a closer look.

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 CareTrust REIT has been growing its earnings per share at 48% a year over the past five years. With recent, rapid earnings per share growth and a payout ratio of 70%, this business looks like an interesting prospect if earnings are reinvested effectively.

We'd also point out that CareTrust REIT 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. CareTrust REIT's is paying out more than half its income as dividends, but at least the dividend is covered by both reported earnings and cashflow. Next, earnings growth has been good, but unfortunately the company has not been paying dividends as long as we'd like. Ultimately, CareTrust REIT comes up short on our dividend analysis. It's not that we think it is a bad company - just that there are likely more appealing dividend prospects out there on this analysis.

Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 5 analysts we track are forecasting for CareTrust REIT for free with public analyst estimates for the company.

If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding 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.