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Thursday, May 9, 2013

The Safety Net: Will the Fortress Fall?

Sepia photograph of the "Atlas" stat...
Sepia photograph of the "Atlas" statue in New York City. (Photo credit: Wikipedia)
By Wealthy Retirement

Chicago, May.9, trading stocks .- I'm writing this week's column from Jerusalem, less than a quarter of a mile from the old city and its centuries-old walls. Earlier in the day, I explored Masada, the 2,000-year-old mountaintop fortress built by King Herod.

Masada was so well fortified that it took the massive Roman army over two years to break through its walls.

So with fortresses on my mind, I'm looking at the dividend safety of Fortress Investment Group (NYSE: FIG), as suggested by a reader.

By the way, if you'd like me to examine the dividend safety of one of your stocks, leave the ticker symbol in the comments section below.

Fortress Investment Group is an asset manager. It runs hedge funds and private equity funds. All told, it has $55.6 million under management, up 4% from the fourth quarter and 20% from a year ago.

This is important because Fortress gets most of its revenue from fees tied to the amount of assets that it manages.

Payout Ratio

The company just reported first-quarter 2013 earnings last week. It earned $0.05 per share but announced a $0.06 per share dividend. For anyone looking at the payout ratio, that should send up a red flag.

For the full year, Fortress earned $0.27 and paid out $0.20 in dividends, which comes out to a payout ratio of 74% - right up against my 75% ceiling. Generally speaking, I don't feel comfortable that a dividend is secure unless the payout ratio is below 75%.

But, if you've read the Safety Net column before, you know that I determine dividend safety by looking at cash flow, not earnings.

I use free cash flow because it's a more accurate representation of a company's ability to generate cash, which is what dividends are paid with. They are not paid with earnings.

Dividends are paid with cash.

In the first quarter of this year, the company generated $85.6 million in cash flow from operations and only invested about $2.3 million in capital expenditures. So free cash flow was $83.3 million.

Fortress paid out $13.9 million in dividends, giving it a payout ratio based on free cash flow of a mere 17%.

For the full year 2012, free cash flow was $131.6 million and dividends paid totaled $32 million - for a payout ratio of 24%.

That's a figure that's well within my comfort level. Even if the dividend were raised, the ratio would still be well below my threshold.

Track Record

Fortress doesn't have much of a track record. It started paying a dividend in 2007. Shortly after, the financial crisis ripped through the markets.

Management had to eliminate the dividend in 2009. Fortress only started paying its shareholders again last year, when it paid $0.05 quarterly. In the first quarter of this year, Fortress raised the quarterly dividend by a penny per share.

My only concern about Fortress' dividend is that the company's fortunes are tied to the direction of the market. A prolonged bear market will force assets under management to decline - which will also reduce revenue, profits and cash flow.

At some point, we're going to have another bear market. When we do, Fortress' numbers will go down. But because the company has enough of a buffer between how much cash it makes and how much it pays out, I don't expect a cut anytime soon.

I can't give it a perfect score because of its limited track record and likelihood of declining earnings at some point in the future. But Fortress looks strong to me.

Dividend Safety Rating: A

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