The Hidden Dividend Treasure Inside Fly High Investing

Imagine discovering that your Fly High Investing portfolio contains a treasure chest you didn’t know was there. You can’t see it by looking at the dividend yield, and you won’t find it by simply comparing a company’s earnings with its dividend. You can’t even find it when our companies report earnings most of the time. But beneath the surface of many of our companies is something we believe is extremely valuable to Fly High investors: earnings that have already been generated but are not yet distributed to shareholders.

Finding that hidden treasure is particularly important to Fly High Investing because every company in the portfolio is either a regulated investment company (RIC), or a real estate investment trust (REIT). Both RICs and REITs are subject to rules requiring them to distribute at least 90% of their taxable earnings to maintain their favorable tax status. That requirement creates an interesting situation for Fly High investors because these companies don’t necessarily distribute all of their earnings at the time they are earned. Some earnings can be kept in reserve for future distributions.

For RICs, reserve earnings are commonly referred to as undistributed taxable income (UTI), and RICs are required to report it once a year. REITs can also have reserve earnings, but they are not required to report it, and there is no official name for it. As a result, sometimes the information is available and sometimes it isn’t. To keep things simple, we refer to these earnings, whether they are generated by RICs or REITs, as reserve earnings. That’s where DCR/RE becomes important.

The conventional Dividend Coverage Ratio (DCR) compares annualized earnings with annualized dividends. DCR is an important measure, but it only considers earnings recognized during the period being measured. DCR/RE takes it one step further. It adds identifiable reserve earnings to annualized earnings before comparing the total with the annualized dividend. In simple terms, DCR asks whether annualized earnings cover the dividend. DCR/RE asks whether current earnings, together with identifiable reserve earnings, support the dividend.

Consider a hypothetical company whose current earnings exactly cover its dividend. Its DCR would be 100%. Now suppose that same company also has reserve earnings equal to 50% of current earnings. Its DCR/RE would be 150%, meaning the company could increase its dividend by as much as 50% and still have a DCR/RE of 100%. This is the hidden treasure we were talking about at the beginning of this article. We don’t know exactly when every dollar in the treasure chest will reach shareholders. Distribution timing can vary from company to company. But the earnings have already been generated and remain available to support future distributions.

At Fly High Investing, we believe dividend investors should know more than simply what a company pays. They should know where the money comes from and whether additional earnings have already been generated that can support future distributions.