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Should Easterly Government Properties, Inc. (NYSE:DEA) Be Part Of Your Income Portfolio?

Simply Wall St

Today we'll take a closer look at Easterly Government Properties, Inc. (NYSE:DEA) from a dividend investor's perspective. Owning a strong business and reinvesting the dividends is widely seen as an attractive way of growing your wealth. 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.

In this case, Easterly Government Properties likely looks attractive to dividend investors, given its 4.8% dividend yield and four-year payment history. 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.

Click the interactive chart for our full dividend analysis

NYSE:DEA Historical Dividend Yield, October 7th 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. 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 76% of Easterly Government Properties's profits were paid out as dividends in the last 12 months. 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. Easterly Government Properties paid out 90% 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 Easterly Government Properties'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 Easterly Government Properties often have different rules governing their distributions, so a higher payout ratio on its own is not unusual.

Is Easterly Government Properties's Balance Sheet Risky?

As Easterly Government Properties 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). Easterly Government Properties has net debt of 8.24 times its 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 1.16 times its interest expense is starting to become a concern for Easterly Government Properties, 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, and we're reluctant to rely on the dividend of companies with these traits. That said, Easterly Government Properties is in the real estate business, which is typically able to sustain much higher levels of debt, relative to other industries.

Remember, you can always get a snapshot of Easterly Government Properties's latest financial position, by checking our visualisation of its financial health.

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. Looking at the data, we can see that Easterly Government Properties has been paying a dividend for the past four years. The dividend has not fluctuated much, but with a relatively short payment history, we can't be sure this is sustainable across a full market cycle. During the past four-year period, the first annual payment was US$0.44 in 2015, compared to US$1.04 last year. Dividends per share have grown at approximately 24% per year over this time.

The dividend has been growing pretty quickly, which could be enough to get us interested even though the dividend history is relatively short. Further research may be warranted.

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 not great to see that Easterly Government Properties's have fallen at approximately 4.2% over the past three years. If earnings continue to decline, the dividend may come under pressure. Every investor should make an assessment of whether the company is taking steps to stabilise the situation.

We'd also point out that Easterly Government Properties 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.

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. First, we think Easterly Government Properties is paying out an acceptable percentage of its cashflow and profit. Earnings per share have been falling, and the company has a relatively short dividend history - shorter than we like, anyway. In summary, Easterly Government Properties has a number of shortcomings that we'd find it hard to get past. Things could change, but we think there are likely more attractive alternatives out there.

Without at least some growth in earnings per share over time, the dividend will eventually come under pressure either from costs or inflation. Businesses can change though, and we think it would make sense to see what analysts are forecasting 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.