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Know This Before Buying Preferred Apartment Communities, Inc. (NYSE:APTS) For Its Dividend

Simply Wall St

Dividend paying stocks like Preferred Apartment Communities, Inc. (NYSE:APTS) 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. If you are hoping to live on your dividends, it's important to be more stringent with your investments than the average punter. Regular readers know we like to apply the same approach to each dividend stock, and we hope you'll find our analysis useful.

In this case, Preferred Apartment Communities likely looks attractive to dividend investors, given its 7.6% dividend yield and eight-year payment history. We'd agree the yield does look enticing. There are a few simple ways to reduce the risks of buying Preferred Apartment Communities for its dividend, and we'll go through these below.

Click the interactive chart for our full dividend analysis

NYSE:APTS Historical Dividend Yield, August 27th 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. 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. Although Preferred Apartment Communities pays a dividend, it was loss-making during the past year. A payout ratio above 100% is definitely an item of concern, unless there are some other circumstances that would justify it.

Preferred Apartment Communities paid out 95% of its cash flow last year. This may be sustainable but it does not leave much of a buffer for unexpected circumstances.

It is worth considering that Preferred Apartment Communities 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 Preferred Apartment Communities's Balance Sheet Risky?

As Preferred Apartment Communities's dividend was not well covered by earnings, 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 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. Preferred Apartment Communities has net debt of 11.23 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. With EBIT of less than 1 times its interest expense, Preferred Apartment Communities's financial situation is potentially quite concerning. Readers should investigate whether it might be at risk of breaching the minimum requirements on its loans. 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 Preferred Apartment Communities's financial position here.

Dividend Volatility

From the perspective of an income investor who wants to earn dividends for many years, there is not much point buying a stock if its dividend is regularly cut or is not reliable. The first recorded dividend for Preferred Apartment Communities, in the last decade, was eight years ago. The dividend has been quite stable over the past eight years, which is great to see - although we usually like to see the dividend maintained for a decade before giving it full marks, though. During the past eight-year period, the first annual payment was US$0.50 in 2011, compared to US$1.05 last year. Dividends per share have grown at approximately 9.7% per year over this time.

The dividend has been growing at a reasonable rate, which we like. We're conscious though that one of the best ways to detect a multi-decade consistent dividend-payer, is to watch a company pay dividends for 20 years - a distinction Preferred Apartment Communities has not achieved yet.

Dividend Growth Potential

Dividend payments have been consistent over the past few years, but we should always check if earnings per share (EPS) are growing, as this will help maintain the purchasing power of the dividend. Preferred Apartment Communities's earnings per share have shrunk at 25% 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 Preferred Apartment Communities's earnings per share, which support the dividend, have been anything but stable.

We'd also point out that Preferred Apartment Communities issued a meaningful number of new shares in the past year. Trying to grow the dividend when issuing new shares reminds us of the ancient Greek tale of Sisyphus - perpetually pushing a boulder uphill. Companies that consistently issue new shares are often suboptimal from a dividend perspective.

Conclusion

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. We're not keen on the fact that Preferred Apartment Communities paid dividends despite reporting a loss over the past year, although fortunately its dividend was covered by cash flow. Unfortunately, there hasn't been any earnings growth, and the company's dividend history has been too short for us to evaluate the consistency of the dividend. There are a few too many issues for us to get comfortable with Preferred Apartment Communities from a dividend perspective. Businesses can change, but we would struggle to identify why an investor should rely on this stock for their income.

Without at least some growth in earnings per share over time, the dividend will eventually come under pressure either from costs or inflation. Businesses can change though, and we think it would make sense to see what analysts are forecasting for the company.

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.