How Important Is The D/E Ratio in Dividend-Paying Stocks?

Published Wed, 7 Oct 2015 12:30 CET by

The debt-to-equity ratio (D/E) is an indication of a company’s reliance on creditors to finance its business. The higher the ratio, the higher the proportion of the firm’s capital that is derived from debt as compared to equity. Normally, a D/E ratio above 2 suggests a high risk, because it means that the company is generating more than twice the operating cash flow required to cover its debt obligations. Conversely, a low D/E ratio implies a secure dividend for shareholders as there is sufficient operating income to offset a potential lower liquidity position.
Another indicator of a secure dividend is the dividend payout ratio. Normally, a 100% payout ratio suggests that a company has zero retained earnings and it pays all its earnings as dividend to its shareholders. However, this may also mean that the firm is not considering to expand its business. Of course, a high or a low payout ratio should be evaluated based on whether a firm is a growth-oriented company or an established company that focuses more on dividend payments.
This article discusses 3 small- and mid-cap stocks: one with a D/E ratio above 2, one below 2 and one that is zero. All three stocks have an average dividend yield of 3% and an average dividend payout ratio of 30%. From the analysis, it becomes clear that a sole figure is not enough to assess if a company is growth-oriented and able to deliver consecutive dividend payments.

Aircastle, CIT Group and Marlin Business Services Stock Performance Year over Year Graph
Aircastle (NYSE: AYR) is a Connecticut-based company that engages in the acquisition, leasing and sale of commercial jet aircraft to airlines globally, as well as in the investment in various aviation assets. Aircastle is trading in the Rental & Leasing Services at a price of $22.03, which combined with an annualized dividend of $0.88, generates a dividend yield close to 4%. The company stands strongly behind its dividend policy. In Q2 2015 it declared the 37th consecutive quarterly dividend payment, whereas the dividend growth over the past decade is 120%, with a shareholder capital return of $242.9 million since 2011. This is sustained by an exceptional operational performance with 99.1% fleet utilization, consistent throughout the business cycle, and strong portfolio management with $2.4 billion growth between 2010 and 2015. Aircastle has a D/E ratio over 2, as a result of a 5.8% increase in its long-term debt from Q1 2015 ($4.3 from $4.04 million) and a 1.6% increase on a YoY basis ($3.8 from $3.74 in 2014). Aircastle has a payout ratio of 40%, which means in the case of a growth company like Aircastle that it retains its earnings to fund future expansion. This is sustained by the acquisition of 19 aircrafts for $553 million as well as the order of 25 new technology Embraer E-Jet E2s aircrafts. Analysts estimate an average annular earnings growth of 8.67% through 2019, and an average 3-year EPS of $2.14, in line with current EPS of $2.18.

CIT Group (NYSE: CIT), CIT bank’s holding company, offers commercial financing and leasing solutions as well as a suite of savings options to operators and suppliers in the aviation and railcar industries across the United States. Headquartered in Livingston, New Jersey, CIT trades in the Credit Services at a current price of $41.29 and it pays an annualized dividend of $0.60, yielding 1.45%. Q2 2015 operating income growth for CIT is 11.2% ($115.3 million from $103.7 million), suggesting that the company generates cash flow from “business as usual” without liquidating its assets to fund dividend payments. Similarly, CIT’s long-term debt was down by 1.2% in Q2 2015 compared to Q1. These two indicators are further sustained by a D/E below 2 and payout ratio of 11.2%. Analyst consensus estimates an average annual earnings growth of 2.67%.

Name Price ($) 52 wk low 52 wk high 52 wk low % 52 wk high % Market Cap ($ b) P/E D/E Beta Payout Ratio
Aircastle 22.03 16.27 25.52 35.40% -13.68% 1.72 10.09 2.40 1.74 40%
CIT Group 41.29 39.28 48.98 5.12% -15.70% 8.34 7.67 1.66 1.52 11%
Marlin 15.95 12.62 15.75 26.39% 1.27% 0.20 11.47 n/a 1.10 39%

Marlin Business Services (Nasdaq: MRLN) trades in the Mortgage Investment industry at a price of $15.95, which is higher than its 52-week high of $15.75. Through its subsidiary, Marlin Leasing Corporation, the New Jersey-based company finances nearly 100 categories of commercial equipment by providing commercial lending products and services to SMEs across the U.S. In Q2 2015, MRLN’s net operating income growth is 2.3% compared to Q1 ($4.15 million from $4.06 million), whereas the company has zero long-term debt. The payout ratio is close to 40%, in line with the Investment Services Industry average payout ratio of 49.43%. Analysts that follow MRLN estimate a 5-year average annular earnings growth of 12%, and an average EPS of $1.63 through 2017, up by 12.4% from current EPS of $1.45.