Understanding metrics is key to making decisions
Understanding metrics is key to making decisions
The mission of every company is to make money. If they do not make enough to pay their expenses, they will eventually cease doing business. Keep in mind that dividends are paid from earnings; however, sometimes earnings do not always mean “true earnings”.
Many companies, such as REITS, do not use GAAP earnings as it does not represent real or true earnings. The reason is that GAAP accounting requires companies to expense depreciation and other non-cash items that do not truly represent a true cash expenses. Thus, many companies use Non-GAAP earnings to provide what they consider to be a true picture of the cash flow or earnings available for distribution.
Investors should make sure to use the metric that provides a more accurate measure of earnings and cash flow.
GAAP is an accounting term that stands for the Generally Accepted Accounting Principles that have been adopted by SEC. GAAP earnings is expressed as EPS (Earnings Per Share).
NON-GAAP is an accounting term that stands for Non-Generally Accepted Accounting Principles that some companies use to better identify certain financial aspects of their company, such as income or cash flow.
Companies that use a Non-GAAP income or cash flow metric such as FFO, AFFO, CAD, NII or DCF usually start with EPS and take out the “non-cash” expenses such as depreciation or impairments that do not really affect income. As an example, if a company is a REIT whose business involves real estate, the depreciation expense that is used to determine Net Income is not really an expense because their investment in real estate is made to increase in value, not decrease.
This is the average yearly earnings growth rate for the company over the last 3 years. We compute this figure based on the type of payout method they use (GAAP or Non-GAAP). It is much easier for a company to pay a distribution when earnings are increasing. Consider comparing earnings growth rate to dividend growth rate.
IPI! provides payout ratios for both common stock dividends as well as preferreds dividends. This is very important because a company must pay out bond debt first, then preferred dividends and finally common stock dividends. As long as a company is able to pay their common stock dividend, the investor can feel a little more secure about the company paying their preferred dividends and interest payments.
As a result, we pay attention to the stock dividend payout ratio of the company issuing the preferred or ETD security. If the ratio is under 1 for the period, then the company is earning enough income to pay their common stock dividend. If the ratio is over 1 for an extended period of time, then the company may consider reducing the dividend or completely eliminating it altogether. That may put the preferred dividend in jeopardy.
Type Payout refers to what earnings or cash flow metric the company uses to determine if it is generating enough income or cash flow to pay the dividend. GAAP earnings are expressed as EPS (Earnings Per Share). Non-GAAP earnings may be expressed as FFO, AFFO, CAD and DCF, etc.
Banks, utilities, insurance companies and others generally use EPS (Earnings Per Share). Master Limited Partnerships (MLP) use DCF (Distributable Cash Flow). REITS use FFO (Funds From Operations) or AFFO (Adjusted Funds From Operations). Business Development Companies use NII (Net Investment Income). Mortgage REITS use CEPS (Core Earnings Per Share). There are other Non-GAAP metrics that companies use to identify the earnings they feel represent their operation.
The dividend payout ratio is an important metric used to determine if the company earns (GAAP or Non-GAAP) enough to pay the common stock dividend. If the dividend is $1 and earnings is $2, the Payout Ratio is 1/2 = .5 or 50%. That shows the company has 2 times the amount in earnings / cash flow available to pay their dividend. If the company is paying more dividends than their earnings or cash flow to support it, then it is considered unsustainable. A ratio under 1 means that earnings is enough to cover the dividend. A ratio over 1 means that income is not enough to pay the dividend on a sustainable basis.
The inverse of Payout Ratio is Coverage Ratio.
Preferred Payout ratio is used to determine if a company earns enough to pay for the preferred dividend. A ratio under 1 means that the dividend is less than earnings. A ratio over 1 means that the income is not enough to pay the dividend on a sustainable basis.
Keep in mind that for GAAP, the preferred dividend in paid from Net Income, which is before Net Income attributable to shareholders. For Non-GAAP, it is paid before the Non-GAAP earnings is determined.
Debt ratios are of huge importance in determining the overall health of a company. Too much debt could be a red flag and could cause problems for any company for many reasons. IPI! uses several debt metrics to measure this important areas.
Interest Coverage Ratio. The interest coverage ratio is a ratio used to determine how easily a company can pay interest on its outstanding debt (including ETD & Trust Preferreds). The interest coverage ratio may be calculated by dividing a company’s earnings before interest and taxes (EBIT) during a given period by the company’s interest payments due within the same period. A company’s ability to meet its interest obligations is an aspect of a company’s solvency and is a very important factor in the return for shareholders. If a company has an Interest Coverage Ratio of less than 1, then it does not have the ability to pay the debt from normal EBIT.
Debt to EBITDA (Earnings Before Interest, Taxes, Depreciation & Amortization). This ratio is a measure of a company’s ability to pay off its incurred debt in relation to its earnings – before Interest, Taxes, depreciation & Amortization. For many companies, EBITDA is a cleaner way of expressing cash flow. The lower the ratio, the better. The higher the ratio, the longer it will take to pay off the debt. If the ratio is too high, it could cause economic difficulty during challenging periods.
Debt To Equity Ratio measures how leveraged the company is or how much of the company’s assets are being financed in relation to company equity. The higher the ratio, the higher the leverage. If debt increases too much, the company may have trouble paying debt obligations during times when EBIT are declining. Debt includes current portion of long term debt + long term debt + capital lease obligation. The ratio is: Debt / Equity
Many of the securities have been rated by Moodys and/or S&P. Green ratings indicate that the rating is designated as “Investment grade”. Here is the breakdown of both Investment Grade and Non-Investment Grade ratings for each rating service.
Aaa Aa1 Aa2 Aa3 A1 A2 A3 Baa1 Baa2 Baa3
AAA AA+ AA AA- A+ A A- BBB+ BBB BBB-
Ba1 Ba2 Ba3 B1 B2 B3 Caa1 Caa2 Caa3
BB+ BB BB- B+ B B- CCC+ CCC CCC- CC C D SD
NF = Not Found
NR = Not Rated
Note: Ratings may not be current.
Income investors are interested in income from dividends and interest. We use several metrics to measure the overall condition of the dividend.
Last Dividend refers mainly to the parent or issuer’s common stock dividend. Those dividends can and do change. Preferred stock and ETDs provide fixed distributions (unless set to a floating rate) and do not change.
Forward Yield is based on annualizing the last dividend and comparing it to the price of the security. FY = Annual Div / Price of Security.
Yield To Call (Y-T-C), is the yield obtained if the security is called on the call date. Paying a premium will reduce yield. Paying a discount will increase the yield. If the call date is in the past, the program will assume the call date is today which will drastically reduce the yield. It is best to always view the forward yield and Y-T-C together.
The formula IPI! uses tries to determine the amount of money that will be earned from today to call date. That includes accrued dividends from last dividend, forward dividend to call date and profit or loss from (sell price – purchase price) assuming you bought at today’s market price.
Calculating Y-T-C can be tough to calculate. Here is how we calculate it if the call date is in the past. We assume that if you purchased today, the company will call today. That means we add accrued dividends from last dividend + 30 more days of dividends + profit or loss from (sell price – today’s market price).
Then comes the issue of annualizing the amount. If the call date is old and the price is below the call price, the earnings in 30 days may be small; but when annualized, is huge. So we have decided to not annualize Y-T-C on old call dates since it is unrealistic that a company will call it the day you buy.
Note: we are open to all ideas or suggestions on Y-T-C formulas.
CAGR stands for Compound Annual Growth Rate. This is the average growth in the Dividends Per Share (DPS) for the last 3 years. Dividend per share (DPS) is the total dividends paid out over an entire year (including interim dividends but not including special dividends) divided by the number of outstanding ordinary shares issued. The CAGR formula is the following: (current year’s DPS / DPS 3 years ago) ^ (1/3) – 1. The yearly dividends are computed using that last 4 quarters vs the same 4 quarters in previous years.
The average annual growth rate is calculated by comparing dividends from 2 years ago to the last years dividend. I Prefer Income compares the last 4 quarters dividends to the previous 4 quarters. The calculation is as follows: (Last 4 quarters) – (previous 4 quarters) / (previous 4 quarters). So if the last 4 quarters dividends were 1.00 and the previous 4 quarters were .80, the formula would be: Step 1: 1.00 – .80 = .20 Step 2: = .20/.80 = .25 or 25%
This metric identifies the number of years a company has increased their dividend every year.
I Prefer Income tracks several historical metrics and compares them to the current metric to determine if the current metric is over or under the historical average. These comparisons provide insight as to market sentiment or the health of the company. Here are examples of historical metrics that we are currently tracking: