JThere are thousands of stocks listed on the stock exchange, but only a small portion have paid an uninterrupted dividend. Some end up joining the list of dividend aristocrats, those companies that have raised their dividend for 25 or more consecutive years. Trust in real estate investment Real estate income (NYSE:O) goes even further.
Calling itself the “monthly dividend company,” Realty Income manages to pay a dividend every month of the year, something few dividend stocks can say. How does a company manage to keep disbursing money to investors? Here’s how Realty Income does it and why investors can feel good about getting paid for years to come.
Understanding the “Secret Sauce” Behind Realty Income
Realty Income is a real estate investment trust (REIT), a type of publicly traded company that, in this case, acquires and leases real estate, primarily in the retail sector. Congress created this corporate structure to allow shareholders to invest in real estate without directly owning it. They are excellent dividend-paying stocks because they must pay out at least 90% of their taxable income in the form of dividends.
REITs typically acquire a property and then lease it to a tenant under a lease agreement. These companies will pay for real estate by issuing debt or new equity. Its weighted average cost of capital (WACC) corresponds to what it costs the company to raise these funds. A company like Realty Income needs to acquire properties that generate a return above its WACC.
This is where things get funny: Realty Income’s balance sheet is firmly rated investment grade by major credit bureaus, with an A rating of Standard & Poor’s. A good credit rating leads to lower interest rates when you go into debt. Additionally, the stock’s popularity with investors often gives it a higher valuation relative to its many peers.
Compare the property income assessment with Simon Real Estate Group, using a stock price/cash flow ratio. A more expensive stock will raise funds more efficiently when issuing new shares. When the stock is doing well, management can issue stock to raise cash without diluting shareholders too much.
Cheap debt and expensive stocks help produce a low long-term WACC of 5.3% for property income, which creates a significant advantage. REITs must create a “spread” or “spread” between the return on assets and the cost of capital; a higher cost of capital may force a business to seek riskier tenants as it must charge more to create a gap.
Real estate income can be more selective, acquiring higher quality tenants who qualify for lower rent terms, because real estate income has that lower cost of capital as a buffer. It can undervalue many competitors while generating profitable and safe cash flow. It also uses net leases in which tenants pay for property maintenance, taxes and insurance.
Where is the dividend today
Realty Income’s dividend continues to flow to this day; a dividend aristocrat, he’s been increasing his payout for 26 years and running. The current dividend yield is just over 4%, which is very much in line with the stock’s long-term average.
The dividend payout ratio is around 82% of cash flow, which makes sense given its payout is essentially the point of being a REIT in the first place. Realty Income is not a fast-growing company, and investors might be better off viewing Realty Income as a long-term asset to buy regularly while letting the dividends begin to accrue.
Want to boost your returns?
Dividend reinvestment is an underrated investment tool. Realty Income has averaged a total return of 10% per year since 1995, assuming you pocketed the dividends. But that annual return can be as high as 15% if you reinvest those dividends instead, turning an initial investment of $10,000 into over $400,000.
Realty Income’s proven ability to navigate challenging environments like COVID-19 and its prudent management could mean investors are poised for similar success over the next two decades and beyond.
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Justin Pope has no position in any of the stocks mentioned. The Motley Fool owns and recommends S&P Global. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.