EPS Is Meaningless: Here’s What Dividend Investors Actually Need to Watch For This Earnings Season

Accelerating Dividends, Business Development Corporations (BDCs), Real Estate Investment Trusts (REITs)

Quarterly earnings reports are often the only way you can get real actionable news about companies, their dividends, and potential stock price moves. However, you want to avoid the Wall Street game of whether a company meets or beats the analyst forecasts. For dividend investors, you need to dig into the numbers to find the metrics that matter concerning whether a company will continue, cut, or grow dividend payments.

There are two mistakes for the income-focused investor to avoid.

First, the earnings hit or miss of the consensus estimate is just a game. Wall Street analysts covering a stock put out their estimates of the expected quarterly earnings per share (EPS) and revenue. The consensus estimate is the average of all forecasts from all the analysts covering a particular stock—whether or not the actual results meet or beat the consensus means nothing. As an investor, you want to compare a company’s results year over year and quarter over quarter.

The other issue for investors in high-yield stocks is that the generally accepted accounting principles (GAAP) EPS number does not give an accurate picture of the company’s ability to continue to pay the current dividend rate. The widely used EPS number can greatly under-report the amount of free cash flow a company generates. The GAAP EPS provides net income after all expenses, and these expenses can include non-cash, bookkeeping-only items. If you are a high-yield stock investor, you need to be familiar with some non-GAAP financial metrics.

Non-GAAP cash flow metrics vary by the various high-yield stocks sectors. These three are the ones to know and understand.

The real estate investment trust (REIT) sector reports funds from operations (FFO). You can think of FFO as EPS with the non-cash expenses added back in. Another approach is to start with EBITDA (earnings before interest, taxes, depreciation, and amortization) and subtract the cash interest and taxes. Many REITs will report AFFO, which is FFO adjusted for special items.

Energy infrastructure companies use distributable cash flow (DCF) as the metric that indicates the money available to pay dividends. Companies calculate DCF through the same approach REITs use to determine FFO.

Business development companies (BDCs) report net investment income (NII). A BDC may have loans and/or equity investments with their client companies. Net investment income will be the interest income from loans, and can be counted on to support dividend payments. Capital gains from equity investments will show up as special dividends.

If a company does not fall into one of these categories, the most common cash flow metric will be referred to as cash available for distribution (CAD). You will see CAD used by companies at which determining free cash flow from the income statement may be a difficult task.

As an income-focused investor, you need to dig (it may be easier or harder to find) the AFFO, DCF, NII, or CAD out of a company’s earnings press release or income statement. You want to find or calculate the free cash flow metric per share. You can then determine the dividend coverage. Also, compare the AFFO, DCF, NII, or CAD per share from the current period to the same number for the previous and year-ago quarterly results.

This are the sorts of terms and measurements I share with my Dividend Hunter readers, especially during earnings season.

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