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Should DiamondRock Hospitality Company (NYSE:DRH) Be Part Of Your Dividend Portfolio?

Simply Wall St

Dividend paying stocks like DiamondRock Hospitality Company (NYSE:DRH) 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. 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.

A high yield and a long history of paying dividends is an appealing combination for DiamondRock Hospitality. We'd guess that plenty of investors have purchased it for the income. The company also bought back stock during the year, equivalent to approximately 3.9% of the company's market capitalisation at the time. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we'll go through this below.

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NYSE:DRH Historical Dividend Yield, August 28th 2019

Payout ratios

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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. DiamondRock Hospitality paid out 50% of its profit as dividends, over the trailing twelve month period. A payout ratio above 50% generally implies a business is reaching maturity, although it is still possible to reinvest in the business or increase the dividend over time.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. DiamondRock Hospitality's cash payout ratio in the last year was 45%, which suggests dividends were well covered by cash generated by the business. It's positive to see that DiamondRock Hospitality'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 DiamondRock Hospitality often have different rules governing their distributions, so a higher payout ratio on its own is not unusual.

Is DiamondRock Hospitality's Balance Sheet Risky?

As DiamondRock Hospitality 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 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). DiamondRock Hospitality is carrying net debt of 4.48 times its EBITDA, which is getting towards the upper limit of our comfort range on a dividend stock that the investor hopes will endure a wide range of economic circumstances.

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 2.72 times its interest expense is starting to become a concern for DiamondRock Hospitality, and be aware that lenders may place additional restrictions on the company as well.

We update our data on DiamondRock Hospitality 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. DiamondRock Hospitality 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$0.33 in 2009, compared to US$0.50 last year. Dividends per share have grown at approximately 4.2% per year over this time.

Dividends have grown relatively slowly, which is not great, but some investors may value the relative consistency of the dividend.

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. It's good to see DiamondRock Hospitality has been growing its earnings per share at 30% a year over the past 5 years. Earnings per share are sharply up, but we wonder if paying out more than half its earnings (leaving less for reinvestment) is an implicit signal that DiamondRock Hospitality's growth will be slower in the future.

Conclusion

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. First, we think DiamondRock Hospitality has an acceptable payout ratio and its dividend is well covered by cashflow. It hasn't demonstrated a strong ability to grow earnings per share, but we like that the dividend payments have been fairly consistent. DiamondRock Hospitality performs highly under this analysis, although it falls slightly short of our exacting standards. At the right valuation, it could be a solid dividend prospect.

Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 10 analysts we track are forecasting for DiamondRock Hospitality 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.