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Is Retail Opportunity Investments Corp. (NASDAQ:ROIC) A Risky Dividend Stock?

Simply Wall St

Is Retail Opportunity Investments Corp. (NASDAQ:ROIC) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. On the other hand, investors have been known to buy a stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.

With a goodly-sized dividend yield despite a relatively short payment history, investors might be wondering if Retail Opportunity Investments is a new dividend aristocrat in the making. We'd agree the yield does look enticing. There are a few simple ways to reduce the risks of buying Retail Opportunity Investments for its dividend, and we'll go through these below.

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NasdaqGS:ROIC Historical Dividend Yield, August 16th 2019

Payout ratios

Dividends are typically paid from company earnings. If a company pays more in dividends than it earned, 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. In the last year, Retail Opportunity Investments paid out 66% of its profit as dividends. A payout ratio above 50% generally implies a business is reaching maturity, although it is still possible to reinvest in the business or increase the dividend over time.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Retail Opportunity Investments paid out 71% of its cash flow as dividends last year, which is within a reasonable range for the average corporation. It's positive to see that Retail Opportunity Investments's dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.

REITs like Retail Opportunity Investments often have different rules governing their distributions, so a higher payout ratio on its own is not unusual.

Is Retail Opportunity Investments's Balance Sheet Risky?

As Retail Opportunity Investments has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. 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. With net debt of 7.87 times its EBITDA, Retail Opportunity Investments 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.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Interest cover of 1.68 times its interest expense is starting to become a concern for Retail Opportunity Investments, and be aware that lenders may place additional restrictions on the company as well. 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 Retail Opportunity Investments'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. Looking at the last decade of data, we can see that Retail Opportunity Investments paid its first dividend at least nine years ago. The company has been paying a stable dividend for a while now, which is great. However we'd prefer to see consistency for a few more years before giving it our full seal of approval. During the past nine-year period, the first annual payment was US$0.24 in 2010, compared to US$0.79 last year. This works out to be a compound annual growth rate (CAGR) of approximately 14% a year over that time.

The dividend has been growing pretty quickly, which could be enough to get us interested even though the dividend history is relatively short. Further research may be warranted.

Dividend Growth Potential

The other half of the dividend investing equation is evaluating whether earnings per share (EPS) are growing. Over the long term, dividends need to grow at or above the rate of inflation, in order to maintain the recipient's purchasing power. In the last five years, Retail Opportunity Investments's earnings per share have shrunk at approximately 4.9% per annum. Declining earnings per share over a number of years is not a great sign for the dividend investor. Without some improvement, this does not bode well for the long term value of a company's dividend.

Conclusion

To summarise, shareholders should always check that Retail Opportunity Investments's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Retail Opportunity Investments's is paying out more than half its income as dividends, but at least the dividend is covered by both reported earnings and cashflow. 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. Overall, Retail Opportunity Investments falls short in several key areas here. Unless the investor has strong grounds for an alternative conclusion, we find it hard to get interested in a dividend stock with these characteristics.

Without at least some growth in earnings per share over time, the dividend will eventually come under pressure either from costs or inflation. See if the 6 analysts are forecasting a turnaround in our free collection of analyst estimates here.

If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding 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.