Considering its anonymous name, you might be surprised at the amount of time dedicated to Realty Income (O) on finance sites like Seeking Alpha. There have been a total of sixteen articles on the REIT since the start of March by my count. Call it one every couple of days on average. Why so much screen space for a seemingly boring real estate company?
Well, I’d wager that four things draw folks to Realty Income. Firstly, it has been pumping out rental dividends to shareholders ever since it was founded in the late-1960s. It establishes commercial property, lets that property out on long-term leases, and then mails the dividends to shareholders. The costs related to property management, such as maintenance, property taxes and insurance, are met by tenants. There is not much more to it than that really.
Around 25% of Realty Income’s revenue comes from a combination of Walgreens, FedEx, Dollar General, CVS Pharmacy, Walmart and Home Depot. They tend to be the kinds of retailers that are more immune to the online shift than most, and so the cashflows look relatively stable. The slight twist here is that Realty Income sends its dividends out on a monthly basis. In fact, it has done so ever since it was founded. Heck, it even trademarked the slogan, “The Monthly Dividend Company”, just to hammer this point home. Needless to say, that will naturally appeal to folks hunting for regular and reliable cash streams.
The brief breakdown of Realty Income’s dividend history is as follows: nearly 50 years of consecutive payments (amounting to $4.5b in total); 78 consecutive quarterly increases; and over 90 dividend increases in total since it listed on the New York Stock Exchange in 1994. It has clocked up approximately 570 consecutive monthly dividend payments since its founding in 1969. It clearly takes the distribution pretty darn seriously.
At this point, you may be looking at that 4.7% annual growth figure and be thinking “so what?”. After all, it is only a couple of points ahead of inflation. Pretty mediocre right? Actually, this leads on to second reason why folks like Realty Income stock: the perpetually high yield. Go over the historical data and you will find that Realty’s average dividend yield has clocked in at around 6.85%. With that as your base, it doesn’t take much growth in order to shift the needle toward serious long-term returns. Think Royal Dutch Shell, which was one of the best performing stocks of the second half of the twentieth century precisely because of its high yield and stable dividends. Realty’s 4.7% growth rate looks absolutely fine when you add it to a stable 6.85% starting yield.
That brings us nicely to the third reason that folks like to discuss Realty Income: the historical returns. Had you purchased 1,000 shares of stock back in 1994, you would have paid about $8k. That would have grown to a value of over $57k by the end of 2016. You can add a further $33k in dividend cash to that too. All-in-all, it leaves us with average annual returns of circa 11% over a twenty-year stretch. Furthermore, this does not even factor in the effect of dividend reinvestment, which would obviously push those returns higher.
Speaking of dividend reinvestment, that leads us into the fourth and final point: the income growth from high yield compounding. Let’s say you set up the Direct Stock Purchase Program for Realty Income stock back in 1994, currently administered by Wells Fargo. Let’s also assume that your initial outlay was $8k for 1,000 shares, as per above. In the first year, you would have been looking at $900 in dividend income due to a starting yield of around 11%.
You decide that you are able to defer that income for a couple of decades. Years of reinvesting high yields, not to mention modest growth and value multiple expansion, sees the value of your initial $8k investment rise to well over $250k by the end of 2016. That is equivalent to average annual returns of almost 17%. On the income side of things, that initial $900 per annum in dividend income is now worth around $11k per annum. That is equivalent to annual growth of over 9% after stripping out inflation.
Okay, so the four points listed above are probably enough to get the gist here. The short version is that consistently high yields can generate great long-term outcomes with only modest growth. If you combine that with a long-term deflating dividend yield (i.e. an expanding valuation multiple), then returns look really good. This is why Realty Income is much featured on financial media sites like Seeking Alpha.
Overvalued Right Now?
The above is all well and good, but what about the current investment case? Well, valuation is the crux of the debate right now. As I type, Realty Income stock currently yields around 4.2%. Pull up the relevant data and you will see how low that is in historical terms. As far as I can tell, Realty Income has never closed a year with a lower dividend yield than its current value. That is a significant point worth thinking about given the dividend accounts for such a huge chunk of total returns. The short-to-medium-term danger here would be a reversion to the historical average eating into forward shareholder returns.
This isn’t a call to sell a stock that has thrown off cash for fifty years. I mean, we have to appreciate the low interest rate world we are in right now. Rates and bond yields have collapsed since Realty first listed back in the mid-1990s. However, this trend has partly driven the incredible total returns to date, and it may also work against investors going forward. On that basis, now is probably not the time to buy Realty Income stock. Its sensitivity to a changing rate environment is pretty clear, and there will almost certainly be more attractive opportunities in the future. If you already own it then I imagine you won’t much care. Just kick back and enjoy what is probably a substantial yield on cost.
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