Dividend paying stocks like Sotherly Hotels Inc. (NASDAQ:SOHO) 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. Unfortunately, it's common for investors to be enticed in by the seemingly attractive yield, and lose money when the company has to cut its dividend payments.
In this case, Sotherly Hotels likely looks attractive to investors, given its 7.6% dividend yield and a payment history of over ten years. It would not be a surprise to discover that many investors buy it for the dividends. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.
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. 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. While Sotherly Hotels pays a dividend, it reported a loss over the last year. 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.
Sotherly Hotels paid out 51% 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 is worth considering that Sotherly Hotels is a Real Estate Investment Trust (REIT). REITs have different rules governing their payments, and are often required to pay out a high portion of their earnings to investors.
Is Sotherly Hotels's Balance Sheet Risky?
As Sotherly Hotels 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. With net debt of 8.57 times its EBITDA, Sotherly Hotels could be described as a highly leveraged company. While some companies can handle this level of leverage, we'd be concerned about the dividend sustainability if there was any risk of an earnings downturn.
Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. With EBIT of less than 1 times its interest expense, Sotherly Hotels's financial situation is potentially quite concerning. Readers should investigate whether it might be at risk of breaching the minimum requirements on its loans. 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.
We update our data on Sotherly Hotels every 24 hours, so you can always get our latest analysis of its financial health, here.
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. For the purpose of this article, we only scrutinise the last decade of Sotherly Hotels's dividend payments. This dividend has been unstable, which we define as having fallen by at least 20% one or more times over this time. During the past ten-year period, the first annual payment was US$0.04 in 2009, compared to US$0.52 last year. Dividends per share have grown at approximately 29% per year over this time. The growth in dividends has not been linear, but the CAGR is a decent approximation of the rate of change over this time frame.
Sotherly Hotels has grown distributions at a rapid rate despite cutting the dividend at least once in the past. Companies that cut once often cut again, but it might be worth considering if the business has turned a corner.
Dividend Growth Potential
With a relatively unstable dividend, it's even more important to evaluate if earnings per share (EPS) are growing - it's not worth taking the risk on a dividend getting cut, unless you might be rewarded with larger dividends in future. Sotherly Hotels's earnings per share have shrunk at 55% a year over the past five years. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and Sotherly Hotels's earnings per share, which support the dividend, have been anything but stable.
To summarise, shareholders should always check that Sotherly Hotels's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Sotherly Hotels's is paying out more than half its income as dividends, but at least the dividend is covered by both reported earnings and cashflow. Second, earnings per share have been essentially flat, and its history of dividend payments is chequered - having cut its dividend at least once in the past. In summary, Sotherly Hotels 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.
Now, if you want to look closer, it would be worth checking out our free research on Sotherly Hotels management tenure, salary, and performance.
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 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.