Question

REITs pay dividends in order to retain their favorable tax status. As the next chapter on stock explains, corporate dividends are made from earnings. REIT dividends often are not made from earnings but the distributions are made from funds from operations (FFO). REIT accounting earnings are adjusted for noncash expenses such as deprecia-tion to determine funds from operations. In addition, a REIT may sell a property and distribute the proceeds. For these reasons, financial analysts often use FFO instead of earnings to analyze a REIT. Distributions are often more highly correlated with per-share funds from operation than they are with earnings per share (EPS). Consider the following FFO and EPS for Washington Real Estate Trust:
Year 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Distributions $1.16 1.23 1.31 1.39 1.47 1.55 1.60 1.64 1.68 1.72 1.73 1.74 1.74 1.47 1.20 1.20
FFO
$1.57 1.79 1.96 1.97 2.04 2.05 2.07 2.12 2.31 2.12 2.06 1.96 1.95 1.84 1.69 1.51
EPS
$1.24 1.26 1.38 1.32 1.13 1.09 1.84 0.88 1.34 0.67 0.71 0.60 1.58 0.35 0.55 1.67
To verify that the dividend distribution is more strongly correlated with FFO than with EPS, compute the correlation coefficients relating the distributions to FFO and to EPS.

Answer 1

Answer:

Correlation coefficients relating the distributions to FFO = 0.8393

Correlation coefficients relating the distributions to EPS = –0.0880

Explanation:

Let X represents distributions, Y represents FFO, and, Z represents EPS.

Note: See the attached excel file for the calculations of Means of X, Y and Z as well as other values.

Therefore, we have:

Correlation coefficients relating the distributions to FFO = (Total of (X - Mean of X) * (Y - Mean of Y)) / ((Total of (X - Mean of X)^2) * (Total of (Y - Mean of Y)^2))^0.5 = 0.7529 / (0.8554 * 0.9408)^0.5 = 0.8393

Correlation coefficients relating the distributions to EPS = (Total of (X - Mean of X) * (Z - Mean of Z)) / ((Total of (X - Mean of X)^2) * (Total of (Z - Mean of Z)^2))^0.5 = –0.1391 / (0.8554 *  2.9200)^0.5 = –0.0880

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