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Dividend paying stocks like iStar Inc. (NYSE:STAR) 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. Yet sometimes, investors buy a stock for its dividend and lose money because the share price falls by more than they earned in dividend payments.
iStar has only been paying a dividend for a year or so, so investors might be curious about its 3.1% yield. The company also bought back stock during the year, equivalent to approximately 2.2% of the company's market capitalisation at the time. Remember though, due to the recent spike in its share price, iStar's yield will look lower, even though the market may now be factoring in an improvement in its long-term prospects. Some simple research can reduce the risk of buying iStar for its dividend - read on to learn more.
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. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Although iStar pays a dividend, it was loss-making during the past year. When a company recently reported a loss, we should investigate if its cash flows covered the dividend.
Unfortunately, while iStar pays a dividend, it also reported negative free cash flow last year. While there may be a good reason for this, it's not ideal from a dividend perspective.
It is worth considering that iStar 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 iStar's Balance Sheet Risky?
Given iStar is paying a dividend but reported a loss over the past year, we need to check its balance sheet for signs of financial distress. 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 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). iStar has net debt of 17.48 times its EBITDA, which we think carries substantial risk if earnings aren't sustainable.
We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. iStar has interest cover of less than 1 - which suggests its earnings are not high enough to cover even the interest payments on its debt. This is potentially quite serious, and we would likely avoid the stock if it were not resolved quickly. 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.
Consider getting our latest analysis on iStar's financial position here.
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. With a payment history of less than 2 years, we think it's a bit too soon to think about living on the income from its dividend. During the past one-year period, the first annual payment was US$0.36 in 2018, compared to US$0.40 last year. Dividends per share have grown at approximately 11% per year over this time.
iStar has been growing its dividend quite rapidly, which is exciting. However, the short payment history makes us question whether this performance will persist across a full market cycle.
Dividend Growth Potential
Examining whether the dividend is affordable and stable is important. However, it's also important to assess if earnings per share (EPS) are growing. Growing EPS can help maintain or increase the purchasing power of the dividend over the long run. It's good to see iStar has been growing its earnings per share at 30% a year over the past 5 years.
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. iStar's dividend is not well covered by free cash flow, plus it paid a dividend while being unprofitable. We were also glad to see it growing earnings, although its dividend history is not as long as we'd like. In summary, iStar has a number of shortcomings that we'd find it hard to get past. Things could change, but we think there are a number of better ideas out there.
Earnings growth generally bodes well for the future value of company dividend payments. See if the 3 iStar analysts we track are forecasting continued growth with our free report on 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.