American Homes 4 Rent is a US$7.4b mid-cap, real estate investment trust (REIT) based in Agoura Hills, United States. REITs own and operate income-generating property and adhere to a different set of regulations. This impacts how AMH’s business operates and also how we should analyse its stock. In this commentary, I’ll take you through some of the things I look at when assessing AMH.
REIT investors should be familiar with the term Fund from Operations (FFO) – a REIT’s main source of cash flow from its day-to-day business activities. FFO is a higher quality measure of earnings because it takes out the impact of non-recurring sales and non-cash items such as depreciation. These items can distort the bottom line and not necessarily reflective of AMH’s daily operations. For AMH, its FFO of US$386m makes up 73% of its gross profit, which means the majority of its earnings are high-quality and recurring.
In order to understand whether AMH has a healthy balance sheet, we have to look at a metric called FFO-to-total debt. This tells us how long it will take AMH to pay off its debt using its income from its main business activities, and gives us an insight into AMH’s ability to service its borrowings. With a ratio of 16%, the credit rating agency Standard & Poor would consider this as significantly high risk. This would take AMH 6.41 years to pay off using operating income alone. Given that long-term debt is a multi-year commitment this is not unusual, however, the longer it takes for a company to pay back debt, the higher the risk associated with that company.
I also look at AMH’s interest coverage ratio, which demonstrates how many times its earnings can cover its yearly interest expense. This is similar to the concept above, but looks at the upcoming obligations. The ratio is typically calculated using EBIT, but for a REIT stock, it’s better to use FFO divided by net interest. With an interest coverage ratio of 3.43x, it’s safe to say AMH is generating an appropriate amount of cash from its borrowings.
I also use FFO to look at AMH’s valuation relative to other REITs in United States by using the price-to-FFO metric. This is conceptually the same as the price-to-earnings (PE) ratio, but as previously mentioned, FFO is more suitable. AMH’s price-to-FFO is 19.18x, compared to the long-term industry average of 16.5x, meaning that it is slightly overvalued.
American Homes 4 Rent can bring diversification into your portfolio due to its unique REIT characteristics. Before you make a decision on the stock today, keep in mind I’ve only covered one metric in this article, the FFO, which is by no means comprehensive. I’d strongly recommend continuing your research on the following areas I believe are key fundamentals for AMH:
- Future Outlook: What are well-informed industry analysts predicting for AMH’s future growth? Take a look at our free research report of analyst consensus for AMH’s outlook.
- Valuation: What is AMH worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether AMH is currently mispriced by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.