Dividend investing is a tried-and-true strategy for generating strong, steady returns in economies both good and bad. But as corporate America's slew of dividend cuts and suspensions over the past few years has demonstrated, it's not enough simply to buy a high yield. You also need to make sure those payouts are sustainable.
First and foremost, dividend investors like a large forward yield. But if a yield gets too high, it may reflect investors' doubts about the payout's sustainability. If investors had confidence in the stock, they'd be buying it, driving up the share price and shrinking the yield.
RAIT Financial yields 6.5%, considerably higher than the S&P's 1.9%.
2. Payout ratio
The payout ratio might be the most important metric for judging dividend sustainability. It compares the amount of money a company paid out in dividends last year to the earnings it generated. A ratio that's too high -- say, greater than 80% of earnings -- indicates that the company may be stretching to make payouts it can't afford, even when its dividend yield doesn't seem particularly high.
The payout ratio is somewhat less important when evaluating Real Estate Investment Trusts (REITs) like RAIT Financial, because they are required to pay out at least 90% of their earnings in the form of dividends in order to avoid paying corporate income taxes.
3. Balance sheet
The best dividend payers have the financial fortitude to fund growth and respond to whatever the economy and competitors throw at them. The debt-to-equity ratio is a good measure of a company's total debt burden. We can also look at interest payments as a percentage of interest revenue for a quick way to gauge how comfortably these REITs can afford to make their interest payments.
Let's examine how RAIT Financial stacks up next to its peers:
Interest Payments/Interest Revenue
RAIT Financial Trust
Resource Capital (NYS: RSO)
Starwood Property Trust (NAS: STWD)
Redwood Trust (NYS: RWT)
Source: Capital IQ, a division of Standard & Poor's.
A large dividend is nice; a large growing dividend is even better. To support a growing dividend, we also want to see earnings growth.
Over the past five years, RAIT's earnings per share have declined at an annual rate of 34%. Its dividend has declined at a 54% rate.
The Foolish bottom line
The economic contraction is a tricky environment for commercial REITs. In particular, RAIT Financial's trailing-twelve-month interest revenue has been declining since December 2007. Of course, with shares having also declined significantly, the stock provides a generous yield. Dividend investors will want to keep an eye on the company's interest income and credit quality to ensure that it's able to continue generating those big payouts.
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At the time thisarticle was published Ilan Moscovitzdoesn't own shares of any companies mentioned. You can follow him on Twitter@TMFDada. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.
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