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Chatham Lodging Trust is a US$918m small-cap, real estate investment trust (REIT) based in West Palm Beach, United States. REITs are basically a portfolio of income-producing real estate investments, which are owned and operated by management of that trust company. They have to meet certain requirements in order to become a REIT, meaning they should be analyzed a different way. I’ll take you through some of the key metrics you should use in order to properly assess CLDT.

Check out our latest analysis for Chatham Lodging Trust

REIT investors should be familiar with the term Fund from Operations (FFO) – a REIT’s main source of cash flow from its day-to-day business activities. FFO is a higher quality measure of earnings because it takes out the impact of non-recurring sales and non-cash items such as depreciation. These items can distort the bottom line and not necessarily reflective of CLDT’s daily operations. For CLDT, its FFO of US$86m makes up 55% of its gross profit, which means the majority of its earnings are high-quality and recurring.

Robust financial health can be measured using a common metric in the REIT investing world, FFO-to-debt. The calculation roughly estimates how long it will take for CLDT to repay debt on its balance sheet, which gives us insight into how much risk is associated with having that level of debt on its books. With a ratio of 15%, the credit rating agency Standard & Poor would consider this as significantly high risk. This would take CLDT 6.77 years to pay off using operating income alone. Given that long-term debt is a multi-year commitment this is not unusual, however, the longer it takes for a company to pay back debt, the higher the risk associated with that company.

I also look at CLDT's interest coverage ratio, which demonstrates how many times its earnings can cover its yearly interest expense. This is similar to the concept above, but looks at the upcoming obligations. The ratio is typically calculated using EBIT, but for a REIT stock, it's better to use FFO divided by net interest. With an interest coverage ratio of 3.21x, it’s safe to say CLDT is generating an appropriate amount of cash from its borrowings.

I also use FFO to look at CLDT's valuation relative to other REITs in United States by using the price-to-FFO metric. This is conceptually the same as the price-to-earnings (PE) ratio, but as previously mentioned, FFO is more suitable. In CLDT’s case its P/FFO is 10.65x, compared to the long-term industry average of 16.5x, meaning that it is undervalued.

Next Steps:

In this article, I've taken a look at Funds from Operations using various metrics, but it is certainly not sufficient to derive an investment decision based on this value alone. Chatham Lodging Trust can bring about diversification for your portfolio, but before you decide to invest, take a look at the other aspects you must consider before investing:

1. Future Outlook: What are well-informed industry analysts predicting for CLDT’s future growth? Take a look at our free research report of analyst consensus for CLDT’s outlook.

2. Valuation: What is CLDT worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether CLDT is currently mispriced by the market.

3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.