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Why You Shouldn't Look At Sunstone Hotel Investors, Inc.'s (NYSE:SHO) Bottom Line

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Sunstone Hotel Investors, Inc. is a US$3.0b mid-cap, real estate investment trust (REIT) based in Irvine, United States. REITs own and operate income-generating property and adhere to a different set of regulations. This impacts how SHO’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 SHO.

View our latest analysis for Sunstone Hotel Investors

A common financial term REIT investors should know is Funds from Operations, or FFO for short, which is a REIT's main source of income from its portfolio of property, such as rent. FFO is a cleaner and more representative figure of how much SHO actually makes from its day-to-day operations, compared to net income, which can be affected by one-off activities or non-cash items such as depreciation. For SHO, its FFO of US$305m makes up 56% of its gross profit, which means the majority of its earnings are high-quality and recurring.

NYSE:SHO Historical Debt, August 20th 2019
NYSE:SHO Historical Debt, August 20th 2019

In order to understand whether SHO 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 SHO to pay off its debt using its income from its main business activities, and gives us an insight into SHO’s ability to service its borrowings. With a ratio of 30%, the credit rating agency Standard & Poor would consider this as significant risk. This would take SHO 3.29 years to pay off using operating income alone, which is reasonable, given that long term debt is a multi-year commitment.

Next, interest coverage ratio shows how many times SHO’s earnings can cover its annual interest payments. Usually the ratio is calculated using EBIT, but for REITs, it’s better to use FFO divided by net interest. This is similar to the above concept, but looks at the nearer-term obligations. With an interest coverage ratio of 6.4x, it’s safe to say SHO is generating an appropriate amount of cash from its borrowings.

In terms of valuing SHO, FFO can also be used as a form of relative valuation. Instead of the P/E ratio, P/FFO is used instead, which is very common for REIT stocks. In SHO’s case its P/FFO is 9.7x, compared to the long-term industry average of 16.5x, meaning that it is undervalued.

Next Steps:

In this article, I've taken a look at Funds from Operations using various metrics, but it is certainly not sufficient to derive an investment decision based on this value alone. Sunstone Hotel Investors can bring about diversification for your portfolio, but before you decide to invest, take a look at the other aspects you must consider before investing:

  1. Future Outlook: What are well-informed industry analysts predicting for SHO’s future growth? Take a look at our free research report of analyst consensus for SHO’s outlook.

  2. Valuation: What is SHO 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 SHO 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.