Realty Income Stock: Unlikely Success, Expensive Valuation

O stock - Realty Income Stock: Unlikely Success, Expensive Valuation

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Despite a severe industry slump, Realty Income (NYSE:O) continues to thrive. The San Diego-based real estate investment trust (REIT) just declared its 583rd monthly dividend amid ongoing revenue and profit growth. O stock certainly has stood out. Many of its peers such as Kimco Realty (NYSE:KIM) and Simon Property Group (NYSE:SPG) have struggled in recent years.

However, Wall Street has taken notice and as a result, the stock price has seen substantial increases over the last year. For this reason, prospective buyers should look past the rising dividend before buying Realty Income stock.

Realty Income Thrives

Realty Income hit a milestone this month. In declaring its 100th hike in its monthly dividend, the payout for each month has reached 22.55 cents per share. It also marks its 583rd monthly dividend payment since the company began making payout about 50 years ago. It also stands out by paying dividends monthly.

As a retail REIT, its industry has faced some of the toughest time in its history. Faced with competition from online shopping, tenants have vacated retail spaces in droves. As a result, once thriving retail spaces have become derelict or have converted to other uses.

Fortunately for Realty Income, brick-and-mortar retail has not died, it is merely shrinking. Also, Realty Income serves tenants that sell products and services less conducive to online retailing. This includes properties such as pharmacies, movie theaters, and so-called “dollar store” retailers.

Moreover, most deals involve agreements known as triple-net leases. Hence, tenants take on the cost of taxes, maintenance, and insurance. The REIT has also diversified into industrial, office, and agricultural property types. These now make up about 19% of Realty Income’s property holdings.

These factors should help O stock continue to thrive. Despite industry challenges, it has maintained a compound average annual return of 16.3% since 1994. With this continuing prosperity, the 100th dividend increase may just be the beginning.

Beware the Rising O Stock Price

However, when one buys into a shrinking industry, it becomes more critical that investors buy at a low price to ensure they come out ahead. Despite serious industry challenges, this stock will not come cheap to investors.

The equity spent most of 2018 in a recovery mode. As a result, the stock now stands at $65 per share, close to its 52-week high. Even on a forward basis, this takes Realty Income stock to a price-to-earnings (PE) of around 46.

Such a multiple might appear reasonable for a high-growth company in an emerging high tech field. However, Realty Income operates in a shrinking industry that expects 8.7% profit growth for this year. Given the REIT’s unlikely success, it deserves a higher multiple than its peers. Still, under those conditions, a 46 forward PE seems quite expensive.

Moreover, investors need to put the dividend in perspective. At a 4.2% yield, that comes in at almost double the S&P 500 average. However, the average dividend yield for equity REITs comes in at just under 4.4%.

Hence, O stock actually pays a below average dividend yield. While this payout also points to the company’s success, it serves as another confirmation that the stock price has moved ahead of itself.

Final Thoughts on O stock

Realty Income thrives in a declining industry. However, with the high PE and the average dividend yield, investors should consider staying away for now.

Amid falling demand for its particular type of real estate, Realty Income has continued to thrive. The REIT leases to clients less affected by online retail. It has also moved into other property types.

This has allowed the REIT to stay on a growth path. Still, Wall Street recognizes its success. As a result, the stock has become an expensive equity in a consolidating industry.

I believe Realty Income will thrive for decades to come. However, at its current earnings multiple, I would look for cheaper REITs operating in less challenged sectors.

As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.

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