1 Overlooked Stock to Buy With Dividends Yielding More Than 6%

By Brian Stoffel Markets Fool.com

Dividend investors are always on the search for underappreciated, overlooked stocks that are yielding far more than they should be. In the Internet Age, these stocks have become harder and harder to find. But today, I want to introduce you to one that I consider to be an exceptional deal: Chesapeake Lodging Trust (NYSE: CHSP), a REIT that is currently yielding a very healthy and sustainable 6.2% dividend.

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Image credit: Getty Images.

After going public in 2010, Chesapeake began building a portfolio of the highest of high-class hotels throughout the United States. Currently, there are 22 hotels in the company's portfolio, with the most important properties being held in San Francisco, Boston, Chicago, and Los Angeles.

Measuring how a hotel REIT performs over time is a lot different from measuring the basics of a typical stock. Below, I've included the three most important operational metrics that investors should follow:

  1. Occupancy: It means exactly what it says -- the percentage of rooms that are, on average, occupied.
  2. RevPAR: This stands for "revenue per available room." This measure allows investors to see beyond occupancy to determine if the company has pricing power and doesn't have to discount rooms to keep them filled.
  3. Adjusted EBITDA margin: In short, this metric allows us to see how well management is allocating its financial resources. These include everything from labor costs to renovations.

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Chesapeake metrics over time.Data source: SEC filings.

Is this just a dividend value trap?

These are very impressive numbers. And yet, the stock has fallen 34% since reaching all-time highs in early 2015. That's because investors are worried about a slowdown in spending among transient, high-class business clients who are looking for places to stay.

Indeed, during the company's third-quarter release, we found out that RevPAR actually fell by 0.7%. That might not sound like too big a deal, but CEO James Francis said it could be a sign of things to come:

Pricing pressure from corporate customers continues to be the primary headwind for our portfolio in the second half of 2016. ... [Average Daily Rates] have been pressured more than expected which in turn has impacted our operating results and margins.

The company expanded on those sentiments in its filing with the SEC, saying that the declines were "attributed to the recent quarterly declines in U.S. corporate profits." Management further stated, "We expect the headwinds we saw during the third quarter to persist through the remainder of 2016."

Indeed, as you can see below, RevPAR in luxury and upper upscale hotels in urban areas is predicted to be the slowest-growing segment of the industry, which is causing a fair deal of anxiety among investors.

Image source: Chesapeake Lodging Trust.

Why this is a steal of a dividend stock

Here's the thing about these trends: They're part of the normal ebb and flow of supply and demand in the lodging sector. For a long time after the Great Recession, it was urban and luxury hotels that had the highest demand. As new hotels were built to meet this demand, oversupply formed. Now, economy airport lodging appears to be the area with limited capacity. Over the next few years, I expect that's where new construction will happen.

Image source: Chesapeake Lodging.

For long-term investors, there are really only two things to focus on: conservative asset allocation and a sustainable dividend. The company has been strategic and conservative in its acquisitions, and has seen its cash cushion grow from just $63 million at the end of 2013 to almost $100 million today. At the same time, debt levels -- which currently stand at $750 million -- have been very manageable.

But perhaps most important, the company's dividend is healthy and sustainable. Instead of free cash flow, the best measure of this is adjusted funds from operations (AFFO). As you can see below, AFFO has steadily grown over time, but there's still a lot of wiggle room for the dividend.

Image source: Chesapeake Lodging Trust.

Over the past 12 months, the company has needed to use only 67% of AFFO to pay its dividend. This not only means that the dividend should continue to grow for the foreseeable future, but that if the company needs to spend on upgrades at existing locations, it has the availability of cash to make that happen.

Personally, I'm putting Chesapeake Lodging on my watch list. As the stock is trading at just 11 times AFFO, I think it could offer outsized, compounding growth for the patient investor.

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Brian Stoffel has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.