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You May Have Been Looking At Equity Commonwealth (NYSE:EQC) All Wrong

Simply Wall St

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Equity Commonwealth is a US$4.1b mid-cap, real estate investment trust (REIT) based in Chicago, United States. REITs own and operate income-generating property and adhere to a different set of regulations. This impacts how EQC’s business operates and also how we should analyse its stock. Below, I'll look at a few important metrics to keep in mind as part of your research on EQC.

See our latest analysis for Equity Commonwealth

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 EQC’s daily operations. For EQC, its FFO of US$90m makes up 76% of its gross profit, which means the majority of its earnings are high-quality and recurring.

NYSE:EQC Historical Debt, June 13th 2019

In order to understand whether EQC 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 EQC to pay off its debt using its income from its main business activities, and gives us an insight into EQC’s ability to service its borrowings. With a ratio of 33%, the credit rating agency Standard & Poor would consider this as significant risk. This would take EQC 3.07 years to pay off using operating income alone, which is reasonable, given that long term debt is a multi-year commitment.

I also look at EQC'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 3.37x, it’s safe to say EQC is generating an appropriate amount of cash from its borrowings.

I also use FFO to look at EQC'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. In EQC’s case its P/FFO is 45.73x, compared to the long-term industry average of 16.5x, meaning that it is highly overvalued.

Next Steps:

As a REIT, Equity Commonwealth offers some unique characteristics which could help diversify your portfolio. However, before you decide on whether or not to invest in EQC, I highly recommend taking a look at other aspects of the stock to consider:

  1. Future Outlook: What are well-informed industry analysts predicting for EQC’s future growth? Take a look at our free research report of analyst consensus for EQC’s outlook.
  2. Valuation: What is EQC 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 EQC is currently mispriced by the market.
  3. 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.

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.