Last Updated on October 22, 2023 by Prakash Kolli
If you are looking for an income with high dividend growth stock that is undervalued, you will be very interested in our next undervalued Real Estate Investment Trust (REIT), Essex Property Trust (ESS) stock. The industry has been beaten down this year because of higher interest rates and recession fears. For example, the Residential industry is down 26.9% since the start of 2022. In addition, the REIT industry is down 26% year to date and in a bear market. This decline provides long-term investors with great opportunities in the Real Estate sector if they are willing to hold on through the higher rate interest environment.
Essex Property Trust, Inc. (ESS) is one company I have had my eye on, and it looks like an excellent area to pick up some shares. As a matter of fact, I bought shares in this price range as it is near a support level of around $200. The chart below shows that the $200 to $210 level was a support level at least six different times. The stock is trading at $208.57 per share as of this writing. Thus, ESS stock looks like it is at an excellent price to pick up shares. In this article, we will determine if the company is undervalued and deserving of our hard earn money.
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Overview of Essex Property Trust
Essex Property Trust, Inc. (ESS), an S&P 500 Index company, is a real estate investment trust (REIT) that acquires, develops, redevelops, and manages multifamily residential properties in specific West Coast markets. The trust currently has ownership interests in 253 apartment communities consisting of approximately 62,000 apartment homes with an additional property in active development.
ESS stock is down 43% since its all-time high in April 2022. The main driver of the stock price decrease has nothing to do with the company itself, as earnings are expected to grow 16% in 2022 and another 7% in 2023. Instead, it has to do with the increasing interest rates affecting all REIT stocks in the markets. Also, the stock was very much overvalued in April.
The current stock price of $208.57 (as of this writing) is right at the lower end of the 52-week range, between $205.76 and $363.36 per share. Thus, Essex Property Trust looks like a stock seemingly in the right place to buy up shares where both the 52-week range and support line meet.
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Essex Property Trust (ESS) Stock Price and Fundamentals
|Market Capitalization||$13.53 B|
|Dividend Rate (FWD)||$8.80|
|Dividend Yield (FWD)||4.21%|
|Payout Ratio (FWD)||144%|
Consensus forward FFO is $14.48 per share for fiscal year 2022, up from $12.49 per share in FY 2022.
ESS Dividend History, Growth, and Yield
We will look at ESS’s dividend history, growth, and yield. We will then determine if it’s still a good buy at current prices.
ESS is considered a Dividend Champion, a company that has increased its dividend for over 25 years. Essex Property Trust is also a Dividend Aristocrat. The REIT is one of the only three Dividend Aristocrat REITs.
In this case, ESS stock has increased its dividend for 28 consecutive years. ESS’s most recent dividend increase was 5%, announced in February 2022. Investors should expect another increase in early 2023.
Additionally, according to Portfolio Insight*, ESS has a five-year dividend growth rate of about 5.49%, which is admirable considering how fast inflation increased last year and this year. The 10-year dividend growth rate is higher at ~7.23%. However, the dividend growth rate has been slowing down in recent years.
Something essential to note is that ESS stock continued to pay its dividend during the most challenging period in the last 100 years. Many businesses and industries cut or suspended their dividend payments during the COVID-19 pandemic. However, unlike many other REITs, Essex Property Trust continued to pay out its dividend and increased them. That is very noteworthy. This fact alone leads me to believe in the strength of the company and the fact that management is focused and committed to the dividend policy.
The company has an excellent dividend yield of approximately 4.2%, more than double the average dividend yield of the S&P 500 Index, and almost the highest value in the past decade. This dividend yield is a respectable initial yield for dividend growth-driven investors. And it may be an excellent stock for income-driven investors who want a 4.5% yield or higher. However, with the company’s recent dividend increase rate, I can see over 5% yield-on-cost (YOC) in the next 3 to 5 years.
ESS’s current dividend yield is higher than its 5-year average dividend yield of ~2.9%. I like to look at this metric because it gives me a good idea if a company I am researching is undervalued or overvalued based on the current and 5-year average yield. Stock price and dividend yield are inversely related. If the stock price increases, the dividend yield decreases, and vice versa.
Is the current dividend safe? This metric is critical to look at as a dividend growth investor. Undervalued dividend stocks sometimes present a “value trap,” and the stock price can continue to decline.
We must look at two critical metrics to determine if the dividend payments are safe yearly. The first one is Funds from Operation per share (FFO), and then we must look into Free Cash Flow (FCF) or Operating Cash Flow (OCF) per share.
Analysts predict that ESS stock will earn an FFO of about $14.48 per share for the fiscal year (FY) 2022. Analysts are 92% accurate when forecasting ESS’s future FFO. Also, the company beats these estimates 8% of the time. In addition, the company is expected to pay out $8.80 per share in dividends for the entire year. These numbers give a payout ratio of approximately 60.8% based on FFO, a conservative value, leaving the company with much room to continue to grow its dividend. Most REITs tend to have a payout ratio of over 80%.
I am excited by having an 80% or lower dividend coverage with a dividend yield of ~4.2% with future growth. At this point, it will allow the company to continue to grow its dividend at a mid-single-digit rate without sacrificing dividend safety. In addition, Essex Property Trust has a dividend payout ratio of 69% on an FCF basis. Thus, the dividend is well covered in both FFO and FCF.
ESS Revenue and Earnings Growth / Balance Sheet Strength
We will now look at how well ESS performed and grew its FFO and revenue throughout the years. When valuing a company, these two metrics are at the top of my list to study. Without revenue growth, a company can’t have sustainable FFO growth and continue paying a growing dividend.
ESS stock’s revenue has been growing reasonably at a compound annual growth rate (CAGR) of about 12.76% for the past ten years, according to Portfolio Insight*. Net income, however, did much better with a CAGR of ~16.9% over the same ten-year period. However, FFO has grown 7% annually for the past ten years and at a CAGR of 1.2% over the past five years.
Since revenue, net income, and FFO did have good growth over the years, we will determine if this stock is attractive based on its valuation and dividend yield. We will talk about the company’s valuation later in this article. In the meantime, analysts predict that the company will grow FFO at a 7.3% rate over the next five years.
Last year’s FFO decreased from $12.82 per share in FY2020 to $12.49 per share for FY2021, a decrease of 3% considering the challenging two years because of the COVID-19 pandemic. Additionally, analysts expect ESS stock to make an FFO of $14.48 per share for the fiscal year 2022, which would be a ~16% increase compared to FY2021. This is something I like to see that future earnings continue to grow.
The company has a solid balance sheet. ESS has an S&P Global credit rating of BBB+, a lower-medium investment-grade rating. Also, the company has a debt-to-equity ratio of 1.1, which is a solid ratio. Thus, the company has a stable balance sheet to overcome significant economic downturns like the COVID-19 pandemic last two years, adding to the dividend safety.
ESS Stock’s Competitive Advantage
Management execution of new properties, either through acquisition or construction of new properties, is the REIT’s most significant competitive advantage going forward. Thus, the efficiency to scale is its most crucial growth driver.
However, there are still risks with an investment in ESS stock. For example, if there is a recession, this can continue to bring the stock price lower as it did in the Great Recession and during the COVID-19 pandemic, which saw prices decrease 56% and 42%, respectively. In addition, fewer people rent apartments during a recession, and occupancy rates decline.
Valuation for Essex Property Trust
One of the valuation metrics that I like to look for is the dividend yield compared to the past few years histories. I also want to look for a lower price-to-earnings (P/FFO) ratio based on the past 5-year or 10-year average. Lastly, I like to use the Dividend Discount Model (DDM). I use a DDM analysis because a business ultimately equals the sum of the future cash flow that that business can provide.
Let’s first look at the P/FFO ratio. ESS has a P/FFO ratio of ~14.5X based on FY 2022 FFO of $14.48 per share. The P/FFO multiple is excellent compared to the past 5-year P/FFO average of 20.8X. If ESS were to vert back to a P/FFO of 20.8X, we would obtain a price of $301.18 per share.
Now let’s look at the dividend yield. As I mentioned, the dividend yield currently is 4.2%. There is good upside potential as ESS’s 5-year dividend yield average is ~2.9%. For example, if ESS were to return to its dividend yield 5-year average, the price target would be $303.45.
The last item I like to look at to determine a fair price is the DDM analysis. I factored in a 9% discount rate and a long-term dividend growth rate of 5.5%. I use a 9% discount rate because of the higher-than-normal current dividend yield. In addition, the projected dividend growth rate is conservative and lower than its past 5-year average. These assumptions give a fair price target of approximately $265.26 per share.
If we average the three fair price targets of $301.18, $303.45, and $265.26, we obtain a reasonable, fair price of $289.96 per share, giving ESS a possible upside of 39% from the current price of $208.57 share price.
Final Thoughts on Essex Property Trust (ESS)
Essex Property Trust is a high-quality company that should meet most investors’ requirements. The company has a market-beating 4.2% yield and a long-term dividend growth history. Past earnings growth has been excellent. However, past performance does not mean it will be the same in the future. However, at the current price, the stock looks to be attractive.
Disclosure: I am long shares of ESS
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My name is Felix Martinez, and I am a Dividend Growth Investor who has invested in dividend growth stocks for the past seven years. I also run a YouTube channel called FiscalVoyage. I have written for SeekingAlpha.com as well as SureDividend.com. I focus on undervalued dividend growth stocks with capital return and dividend income potential. Make sure to follow me on my YouTube Channel. See you there.