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Know This Before Buying Colony Capital, Inc. (NYSE:CLNY) For Its Dividend

Simply Wall St

Dividend paying stocks like Colony Capital, Inc. (NYSE:CLNY) 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.

Colony Capital yields a solid 9.8%, although it has only been paying for three years. It's certainly an attractive yield, but readers are likely curious about its staying power. The company also bought back stock during the year, equivalent to approximately 1.6% of the company's market capitalisation at the time. There are a few simple ways to reduce the risks of buying Colony Capital for its dividend, and we'll go through these below.

Explore this interactive chart for our latest analysis on Colony Capital!

NYSE:CLNY Historical Dividend Yield, September 3rd 2019

Payout ratios

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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. Although it reported a loss over the past 12 months, Colony Capital currently pays a dividend. When a company is loss-making, we next need to check to see if its cash flows can support the dividend.

Colony Capital paid out 75% of its cash flow as dividends last year, which is within a reasonable range for the average corporation.

Colony Capital is a REIT, which is an investment structure that often has different payout rules compared to other companies. It is not uncommon for REITs to pay out 100% of their earnings each year.

Is Colony Capital's Balance Sheet Risky?

Given Colony Capital 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 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). With net debt of 8.33 times its EBITDA, Colony Capital 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.

We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. With EBIT of less than 1 times its interest expense, Colony Capital'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.

Consider getting our latest analysis on Colony Capital's financial position here.

Dividend Volatility

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. This company's dividend has been unstable, and with a relatively short history, we think it's a little soon to draw strong conclusions about its long term dividend potential. During the past three-year period, the first annual payment was US$1.08 in 2016, compared to US$0.44 last year. This works out to a decline of approximately 59% over that time.

When a company's per-share dividend falls we question if this reflects poorly on either external business conditions, or the company's capital allocation decisions. Either way, we find it hard to get excited about a company with a declining dividend.

Dividend Growth Potential

Given that dividend payments have been shrinking like a glacier in a warming world, we need to check if there are some bright spots on the horizon. Over the past five years, it looks as though Colony Capital's EPS have declined at around 72% a year. A sharp decline in earnings per share is not great from from a dividend perspective, as even conservative payout ratios can come under pressure if earnings fall far enough.

Conclusion

To summarise, shareholders should always check that Colony Capital's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. We're not keen on the fact that Colony Capital paid dividends despite reporting a loss over the past year, although fortunately its dividend was covered by cash flow. 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. There are a few too many issues for us to get comfortable with Colony Capital from a dividend perspective. Businesses can change, but we would struggle to identify why an investor should rely on this stock for their income.

Now, if you want to look closer, it would be worth checking out our free research on Colony Capital 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 editorial-team@simplywallst.com. 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.