Why Dividend Investors Should Never Trust A Stock Screener

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If you’re a serious dividend investor, you should never trust a stock screener.

They might be OK for blue-chip stocks like Pfizer (PFE) and Procter & Gamble (PG). But these stocks don’t pay enough to properly fund a retirement portfolio powered by dividends anyway.

The big problem with screeners is that they get tripped up when yields get serious. They handle the 2% and 3% payers alright. They’ll spit back a fairly accurate dividend payout ratio based on earnings, and give you price-to-earnings metrics that are fair enough.

But high-yield structures like REITs and BDCs? Forget it. They break the machines.

The cash cows we buy to secure yields of 6%, 7% and 8% or more are unique. Traditional “earnings” don’t really matter. Each vehicle has its own measure of profitability that traditional screeners can’t deal with. For example:

  • Real estate investment trusts (REITs): Funds from operations (FFO) adds in factors such as depreciation and amortization to get a truer sense of the real estate business.
  • Master limited partnerships (MLPs): Distributable cash flow (DCF) is the cash left over after obligations to the general partner have been paid out, and debts are paid.
  • Business development companies (BDCs): Net investment income (NII) is pretax income generated from investments such as stocks, bonds and loans, minus expenses.

Stock screeners tend to get the stats on these firms dead wrong.

The solution? We must calculate these numbers ourselves. It’s a bit of work, sure, but it’s also how we bag big dividends that most investors don’t even know about.

To evaluate the dividend safety of a REIT, I add up per-share FFO on my own, then use that to calculate price-to-FFO (valuation) and FFO payout ratio (which determines how safe the dividend is).

I’ll discuss three high-paying REITs that the machines get wrong, but first, let’s do a couple real-life examples.

First up, let’s look at Monmouth Real Estate Investment Corporation (MNR). I recently highlighted this warehousing REIT because the screeners flagged its seemingly outrageous payout ratio.

The screeners got that wrong, of course, and they’ve flubbed MNR’s valuation, too. By a lot.

FinViz

FinViz

I like warehousing REITs as much as the next guy. But would you pay a massive 67% premium to Amazon.com (AMZN)—one of the most perpetually expensive stocks on Wall Street—to get in?

I wouldn’t. And I don’t have to.

A manual calculation shows that Monmouth trades at 15 times its trailing 12-month FFO. That’s not the cheapest price you’ll ever buy a REIT at, but it’s a fair (and more importantly, accurate) valuation.

This doesn’t just happen with smaller, less covered REITs like Monmouth. Screeners give even the most popular real estate plays a bad name.

FinViz

FinViz

Here, “Monthly Dividend Company” Realty Income (O) appears priced to perfection, with a P/E of 52 that’s typically reserved for newly profitable technology upstarts. But again, FFO tells a different tale.

Contrarian Outlook

Contrarian Outlook

Realty Income is one of the most respected stocks in retail real estate, and it boasts one of the best dividend track records out there. It’s going to trade at a premium. But its price/FFO is at least within the confines of reality. That 52 P/E simply isn’t.

If this sounds frustrating, it is. But remember: Screener errors like this work in our favor, because they allow us to secure yields that simpler dividend minds don’t even see.

Now, let’s look at a few more P/E fakeouts that scare normal investors out of high yields of 5.0%-11.1%.

Global Net Lease (GNL)

Dividend Yield: 11.1%

TTM P/E Ratio: 391.6

Global Net Lease (GNL) is somewhat similar to Realty Income in that it’s a single-tenant, net-lease REIT. But it’s actually more diversified than Realty Income in that it operates not just in the U.S., but also the U.K., Germany, France, Belgium, the Netherlands, Luxembourg and Finland.

The portfolio isn’t as expansive, but there’s still some breadth. Global Net Lease owns 343 properties leased out to 112 companies across 45 industries, including the likes of America’s FedEx (FDX), German utility RWE and Netherlands bank ING Groep (ING).

GNL’s 11% yield is the obvious draw, and if earned the right way, that’s a dividend worth overpaying a little for. But 1.) I wouldn’t pay 390 times earnings for a rock-solid 20% yield, and 2.) GNL’s dividend hasn’t budged since it was initiated in 2015—the yield is a product of a falling share price.

On an FFO basis, it’s a different story—but still not a picture-perfect one.

Global Net Lease looks downright cheap at less than 10 times trailing adjusted FFO, but I think you should avoid this stock nonetheless, for three reasons:

  1. GNL’s dividend is set at 53.25 cents per quarter—that’s $2.13 per year, which is well more than the $2.02 per share it has earned in FFO over the past 12 months.
  2. The recent trend for its FFO is down, too. It earned $2.09 per share over the previous 12 months.
  3. The dividend recently switched from monthly to quarterly. That’s not a warning sign, but monthly dividends are a sweet perk that you hate to lose.

In short, everything having to do with the dividend is heading in the wrong direction. I’m not inclined to bite—even at this cheap price.

Stag Industrial (STAG)

Dividend Yield: 5.0%

TTM P/E Ratio: 46.7

Stag Industrial (STAG), I’m happy to say, is better about living within its means.

Stag Industrial, like Monmouth, operates in the industrial space, which is a massive $1 trillion market opportunity. But Stag has a very specific tenant in mind. Stag targets single tenants, which is closer to a $500 billion opportunity, though when you whittle that down to potential tenants that meet Stag’s investment criteria, its target asset universe is whittled down to $250 billion.

Even then, this REIT has oodles of room to grow. While it owns and/or operates 81.2 million square feet of space across 409 buildings in 38 states, that represents a mere 1.5% sliver of that target asset universe.

The P/E screener gets yet another REIT wrong, though even by sheer net income, Stag Industrial isn’t as ludicrously overpriced as other real estate plays.

And from an FFO standpoint, STAG’s valuation is downright typical.

Stag has routinely improved its funds from operations, which at $1.81 per share over the past 12 months is more than enough to cover its 11.92-cent monthly dividend. That payout, by the way, has been ticking higher for years.

I lauded Stag for its potential back near the end of 2018, and I think there’s still plenty to like. It deals in a large, stable market that’s organically growing thanks to the expansion of e-commerce. The U.S. Census Bureau and Moody’s say e-commerce, which currently makes up just 10% of U.S. retail sales, will explode to 23% by 2025—a wind in the sail of warehousing REITs.

Gladstone Commercial (GOOD)

Dividend Yield: 7.1%

TTM P/E Ratio: 931.3

Now, let’s look at a member of the Gladstone family.

Gladstone Commercial (GOOD) is one of a group of public investment vehicles that also include Gladstone Investment Corporation (GAIN), Gladstone Capital Corporation (GLAD) and Gladstone Land Corporation (LAND). As a group, they invest in (and buy) lower middle market companies, and deal in commercial and farmland real estate.

Gladstone Commercial, as the name would imply, is a commercial REIT that invests in a diversified group of single- and anchored multi-tenant properties in 24 states. Its 102 properties are primarily office (63%) and industrial (32%) in nature, though it does have a little exposure to retail (3%) and medical offices (2%). Better still, it has a diversified tenant list that includes General Motors (GM), Automatic Data Processing (ADP) and Morgan Stanley (MS), and no single tenant makes up more than 4% of rent.

Importantly, Gladstone isn’t a passive rent collector. Its management team will actually work with tenants to make value-add capital improvements ranging from repaving parking lots to full building expansions, and even help them reduce their regular operating expenses.

Revenues have steadily climbed the wall over the past few years, from $73.8 million in 2014 to $106.8 million last year. (And Gladstone is on pace for another year of growth.) FFO hasn’t grown as consistently but is up each of the past two years. I’m also willing to give a pass on that given what the company is doing to cut back its leverage.

But a price/FFO of less than 14 sounds acceptable for a company with Gladstone’s growth potential? That I can live with.

This REIT has outperformed the Vanguard Real Estate ETF (VNQ) on a total return basis since I last analyzed it early January, and nothing has happened to change my mind.

Gladstone looks pretty good.

Brett Owens is chief investment strategist for Contrarian Outlook. For more great income ideas, click here for his latest report How To Live Off $500,000 Forever: 9 Diversified Plays For 7%+ Income.

Disclosure: none

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