Bust The Tipsters! - Case #1...The Case of the Uncovered Dividend

Bust The Tipsters!

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Case #1 The Case of the Uncovered Dividend
by MF Hoyden
You spotted industrial spy Dr. Mortimer Stocktout this morning at Oil Rig Property Trust's tour of their Houston apartment buildings. It appeared that Mortimer and his gang of evil market manipulators were at it again. Between bagels at breakfast and martinis at lunch, Stocktout was busy whispering to REIT (Real Estate Investment Trust) newbie Willie B. Gullible that maybe there was something wrong with this REIT.
"How is it that this REIT can pay a dividend that is more than it earns?" Dr. Stocktout says, "Look at the earnings for Oil Rig's buildings. How could they pay a dividend last year of $1.84 per share when they only had earnings of $0.85? Think about shorting this REIT."
"Good question," you thought. "Could Dr. Stocktout really be on to something here?"
Just as you were about to rush to your discount broker, you heard the soft jingle of a Fool's cap as a handsome, nattily dressed gentleman approached you.
"My name's Fool, Motley Fool," the stranger said. "I'm in real estate."
He swished one end of the tri-tipped cap off the lapel of his Saville Row suit as he continued. "Investors buy real estate investment trusts for income. So the safety of the dividend is paramount. But you can't look at a REIT's earnings the same way you would most other companies."
He ordered another mineral water as he played with the keys to his car. "There's nothing at all wrong with your confusion. Everyone who looks at REITs for the first time makes this mistake."
Then Fool looks directly at Dr. Stocktout and says, "Nice try Doctor. But this time you devilish scam won't work. The Fool knows that you should ignore a REIT's EPS because,
1. It overstates the value of the property
2. It includes the property's depreciation
3. It excludes the property's depreciation
4. It does not adjust for inflation

The answer is 2.
You ignore a REIT's EPS because it includes the property's depreciation. According to Motley Fool, "Basically, REIT earnings under "normal" accounting rules are distorted by the fact that they compute "depreciation" as the tax code does. The IRS and accounting law say that all the value of an apartment or office building should be written off in 39.5 years. If the builder of Rockefeller Center in the 30s still held it, the value of the property according to the IRS would be nothing. Zippo.. Nada... Niente. But we know it was just purchased for well over a BILLION dollars. The IRS and the accounting laws only recognize real value when the building is sold."
"Soooo... we ignore EPS because we think depreciation distorts earnings. We really buy REITs because we love the dividend. What's a poor analyst or investor to do? In lieu of EPS we use an accounting concept called FFO or "Funds From Operations."
"FFO strips out the deductions for depreciation and amortization from earnings to get at the company's real ability to pay its dividend."
"So," you say, "I should ignore earnings when it comes to REITs and concentrate of funds from operations... or 'FFO'?"
"Right", said Fool, who disappears into the cyber-ether.

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RULES & PRIZES \| HEROES & VILLAINS \| STANDINGS \| ARCHIVE
Case #1 The Case of the Uncovered Dividend by MF Hoyden You spotted industrial spy Dr. Mortimer Stocktout this morning at Oil Rig Property Trust's tour of their Houston apartment buildings. It appeared that Mortimer and his gang of evil market manipulators were at it again. Between bagels at breakfast and martinis at lunch, Stocktout was busy whispering to REIT (Real Estate Investment Trust) newbie Willie B. Gullible that maybe there was something wrong with this REIT. "How is it that this REIT can pay a dividend that is more than it earns?" Dr. Stocktout says, "Look at the earnings for Oil Rig's buildings. How could they pay a dividend last year of $1.84 per share when they only had earnings of $0.85? Think about shorting this REIT." "Good question," you thought. "Could Dr. Stocktout really be on to something here?" Just as you were about to rush to your discount broker, you heard the soft jingle of a Fool's cap as a handsome, nattily dressed gentleman approached you. "My name's Fool, Motley Fool," the stranger said. "I'm in real estate." He swished one end of the tri-tipped cap off the lapel of his Saville Row suit as he continued. "Investors buy real estate investment trusts for income. So the safety of the dividend is paramount. But you can't look at a REIT's earnings the same way you would most other companies." He ordered another mineral water as he played with the keys to his car. "There's nothing at all wrong with your confusion. Everyone who looks at REITs for the first time makes this mistake." Then Fool looks directly at Dr. Stocktout and says, "Nice try Doctor. But this time you devilish scam won't work. The Fool knows that you should ignore a REIT's EPS because, 1. It overstates the value of the property 2. It includes the property's depreciation 3. It excludes the property's depreciation 4. It does not adjust for inflation
The answer is 2. You ignore a REIT's EPS because it includes the property's depreciation. According to Motley Fool, "Basically, REIT earnings under "normal" accounting rules are distorted by the fact that they compute "depreciation" as the tax code does. The IRS and accounting law say that all the value of an apartment or office building should be written off in 39.5 years. If the builder of Rockefeller Center in the 30s still held it, the value of the property according to the IRS would be nothing. Zippo.. Nada... Niente. But we know it was just purchased for well over a BILLION dollars. The IRS and the accounting laws only recognize real value when the building is sold." "Soooo... we ignore EPS because we think depreciation distorts earnings. We really buy REITs because we love the dividend. What's a poor analyst or investor to do? In lieu of EPS we use an accounting concept called FFO or "Funds From Operations." "FFO strips out the deductions for depreciation and amortization from earnings to get at the company's real ability to pay its dividend." "So," you say, "I should ignore earnings when it comes to REITs and concentrate of funds from operations... or 'FFO'?" "Right", said Fool, who disappears into the cyber-ether.