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Could Extended Stay America, Inc. (NASDAQ:STAY) be an attractive dividend share to own for the long haul? Investors are often drawn to strong companies with the idea of reinvesting the dividends. 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.
With a goodly-sized dividend yield despite a relatively short payment history, investors might be wondering if Extended Stay America is a new dividend aristocrat in the making. We'd agree the yield does look enticing. The company also bought back stock equivalent to around 1.6% of market capitalisation this year. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we'll go through this below.
Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. So we need to be form a view on if a company's dividend is sustainable, relative to its net profit after tax. In the last year, Extended Stay America paid out 80% 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. Extended Stay America paid out 82% of its cash flow last year. This may be sustainable but it does not leave much of a buffer for unexpected circumstances. 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.
Is Extended Stay America's Balance Sheet Risky?
As Extended Stay America 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. Extended Stay America is carrying net debt of 3.72 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.
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 Extended Stay America, and be aware that lenders may place additional restrictions on the company as well.
Remember, you can always get a snapshot of Extended Stay America's latest financial position, by checking our visualisation of its financial health.
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. Looking at the data, we can see that Extended Stay America has been paying a dividend for the past five years. During the past five-year period, the first annual payment was US$0.60 in 2014, compared to US$0.92 last year. This works out to be a compound annual growth rate (CAGR) of approximately 8.9% a year over that time.
Extended Stay America has been growing its dividend at a decent rate, and the payments have been stable despite the short payment history. This is a positive start.
Dividend Growth Potential
The other half of the dividend investing equation is evaluating whether earnings per share (EPS) are growing. Growing EPS can help maintain or increase the purchasing power of the dividend over the long run. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see Extended Stay America has grown its earnings per share at 19% 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 Extended Stay America is not retaining those earnings to reinvest in growth.
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 Extended Stay America is paying out an acceptable percentage of its cashflow and profit. We were also glad to see it growing earnings, although its dividend history is not as long as we'd like. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than Extended Stay America out there.
Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 9 analysts we track are forecasting for Extended Stay America for free with public analyst estimates for the company.
We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 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.