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Today we'll take a closer look at Essex Property Trust, Inc. (NYSE:ESS) 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. Yet sometimes, investors buy a popular dividend stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.
While Essex Property Trust's 2.6% dividend yield is not the highest, we think its lengthy payment history is quite interesting. There are a few simple ways to reduce the risks of buying Essex Property 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. As a result, we should always investigate whether a company can afford its dividend, measured as a percentage of a company's net income after tax. In the last year, Essex Property Trust paid out 56% of its profit as dividends. 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.
In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Essex Property Trust paid out 60% of its cash flow as dividends last year, which is within a reasonable range for the average corporation. It's positive to see that Essex Property 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.
Is Essex Property Trust's Balance Sheet Risky?
As Essex Property 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 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). Essex Property Trust has net debt of 5.80 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. With EBIT of 2.32 times its interest expense, Essex Property Trust's interest cover is starting to look a bit thin. High debt and weak interest cover are not a great combo, and we would be cautious of relying on this company's dividend while these metrics persist.
Remember, you can always get a snapshot of Essex Property Trust's latest financial position, by checking our visualisation of its financial health.
From the perspective of an income investor who wants to earn dividends for many years, there is not much point buying a stock if its dividend is regularly cut or is not reliable. Essex Property Trust 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 the past ten-year period, the first annual payment was US$4.08 in 2009, compared to US$7.80 last year. Dividends per share have grown at approximately 6.7% per year over this time.
Dividends have grown at a reasonable rate over this period, and without any major cuts in the payment over time, we think this is an attractive combination.
Dividend Growth Potential
The other half of the dividend investing equation is evaluating whether 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 Essex Property Trust has grown its earnings per share at 15% per annum over the past five years. Essex Property Trust's earnings per share have grown rapidly in recent years, although more than half of its profits are being paid out as dividends, which makes us wonder if the company has a limited number of reinvestment opportunities in its business.
To summarise, shareholders should always check that Essex Property Trust's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. First, we think Essex Property Trust is paying out an acceptable percentage of its cashflow and profit. That said, we were glad to see it growing earnings and paying a fairly consistent dividend. Overall we think Essex Property Trust is an interesting dividend stock, although it could be better.
Earnings growth generally bodes well for the future value of company dividend payments. See if the 18 Essex Property Trust analysts we track are forecasting continued growth with our free report on 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 firstname.lastname@example.org. 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.