Danger Lurking in HCP Stock Dividend Payout Ratio Analysis?

Medical City facility, Dallas. Source: HCP.

Dividend investors have simple needs: they want to own stocks that will provide them with the income they need without any negative surprises. For years, investors have looked at real estate investment trusts to provide much-needed income, and healthcare-oriented REIT HCP (DOC 1.40%) gives shareholders a different type of exposure to real estate than most REITs offer. With its network of properties including hospitals, senior housing, medical office buildings, and skilled nursing facilities, HCP relies on the health of the healthcare industry to sustain its income. Yet some investors get nervous when they notice that HCP pays out almost all of its earnings through dividends. Should HCP shareholders worry? Let's take a closer look at HCP by doing a dividend payout ratio analysis to see if its healthy dividend yield is sustainable.

Dividend Stats on HCP

Source: Yahoo! Finance.

Should HCP dividend investors worry?
For those who aren't familiar with how real estate investment trusts work, looking at HCP's earnings and dividends seems to raise red flags about the sustainability of its payouts. After all, with just a penny separating HCP's dividend and its trailing earnings, all it would take is a temporary minor slowdown to put HCP in a position in which it's paying more in dividends than it earns.

In part, though, those worries reflect a fundamental misunderstanding about how REITs work. In order to qualify for REIT status, a company has to pay out at least 90% of its earnings in the form of dividend distributions. That inevitably leads to earnings payout ratios that are much higher than you tend to see from ordinary companies that have greater latitude to hold onto their earnings for internal business reinvestment, stock buybacks, or other purposes. In fact, if a REIT's earnings payout ratio were much lower than 100%, investors would need to be nervous about whether the entity is meeting its obligations to the IRS to maintain its tax status.

Solana Olney. Source: HCP.

In addition, whenever you deal with real estate, issues like depreciation and maintenance become substantial factors in determining earnings. Investors can often get a better sense of the financial health of a REIT by looking at its funds from operations. When you calculate dividend payout ratios based on funds from operations, you'll see consistent quarterly results in the 70% to 75% range, which is consistent with a solid financial foundation for the REIT.

 A solid track record of dividend growth

The best reason to be optimistic about HCP's future dividend prospects is that the REIT has an enviable track record of having made regular increases to its dividend payouts over time. In fact, HCP holds the distinction of being a member of the elite Dividend Aristocrats list, with its 29-year record of consecutive annual dividend increases qualifying it for the prestigious honor. HCP's dividend increases tend to be relatively modest, with boosts in the 4% to 5% range annually over the past few years, but they still provide dividend growth that adds up in the long run.

Moreover, HCP continues to benefit from favorable trends in healthcare. An aging population will raise demand for senior housing and skilled nursing, and opportunities to build out the healthcare infrastructure of the U.S. should keep popping up regularly in the years to come. With a substantial portion of its revenue coming from people who are responsible for paying their own bills rather than relying on public assistance from Medicare and other government healthcare programs, HCP reduces its risk of future government spending cuts hurting its results.

HCP investors have little to worry about when it comes to their dividend payments. With REITs requiring high earnings payout ratios, HCP has demonstrated its ability to keep growing even during challenging times in the healthcare industry, and things are now looking much brighter for the industry. Shareholders can count on HCP's wanting to maintain its membership in the Dividend Aristocrats to drive dividend policy in the years and decades to come.