I have been using my new evaluation model now for about a month now. So far, I have been quite pleased with the results. It is helping me to efficiently review a lot of dividend stocks and identify those with strong financials, that are likely to continue increasing their dividends and that are fairly priced. As I was developing and testing the new model I noticed it had a distinct dislike of Real Estate Investment Trusts (REITs) and utilities.
This got me to looking at these classes of stocks and asking the fundamental question, 'Are they really quality dividend investments?' Sure both are known to have above average yields, but as any knowledgeable dividend investor will tell you, current yield is just one small part of what makes up a great dividend stock.
I currently own three utilities and three REITs. In addition to those, I follow three other utilities and three other REITs. Let's take a look at some of them and determine if they are good dividend investments:
REITsFor a company to consistently raise its dividends, it must generate strong free cash flows sufficient enough to meet other obligations, such as debt, before paying a dividend. I look for a maximum of 45% Debt to Total Capital and a maximum of 60% Free Cash Flow Payout with the last 10 years positive.
Health Care Property Investors Inc. (HCP) - 0 Stars
Debt to Total Capital: 52%
Free Cash Flow Payout: 131%
Realty Income Corp (O) - 0 Stars
Debt to Total Capital: 47%
Free Cash Flow Payout: -65%
Federal Realty Investment Trust (FRT) - 2 Stars
Debt to Total Capital: 51%
Free Cash Flow Payout: 101%
Kimco Realty Corporation (KIM) - 2 Stars
Debt to Total Capital: 55%
Free Cash Flow Payout: -1753%
National Retail Properties, Inc. (NNN) - 4 Stars
Debt to Total Capital: 39%
Free Cash Flow Payout: -144%
SJW Corp. (SJW) - 0 Stars
Debt to Total Capital: 49%
Free Cash Flow Payout: -94%
Progress Energy, Inc. (PGN) - 1 Stars
Debt to Total Capital: 56%
Free Cash Flow Payout: -36%
Atmos Energy Corporation (ATO) - 1 Stars
Debt to Total Capital: 54%
Free Cash Flow Payout: 1045%
Black Hills Corp. (BKH) - 2 Stars
Debt to Total Capital: 48%
Free Cash Flow Payout: -105%
Integrys Energy Group, Inc. (TEG) - 3 Stars
Debt to Total Capital: 18%
Free Cash Flow Payout: -47%
Consolidated Edison, Inc. (ED) - 3 Stars
Debt to Total Capital: 52%
Free Cash Flow Payout: -40%
With the exception of NNN and TEG, each of the above companies failed the Debt to Total Capital and Free Cash Flow Payout tests. NNN and TEG passed the Debt to Total Capital test while failing the Free Cash Flow Payout test. All the above companies had multiple years of negative FCF over the last 10 years thus their dividends are supported via non-operating cash such as debt issuances and property sales. Ironically, NNN was the only 4 Star stock and it just recently froze its dividend.
Most REITs and utilities may provide your income portfolio with an additional boost in yield, but may end up costing you more in the long run. I will continue to look at REITs and utilities, but they must measure up like any other stock.
Full Disclosure: Long HCP, O, NNN, PGN, TEG, ED. See a list of all my income holdings here.
Tags: [ATO] [BKH] [ED] [FRT] [HCP] [KIM] [NNN] [O] [PGN] [SJW] [TEG]