An investor could decide to buy now and hope that Realty Income grows quickly and sufficiently to get to an improved yield on cost. I don’t recommend that approach. Realty Income’s 1Q16 report indicates they are on track to meet or beat their full year 2016 guidance. The chart below shows both the 1Q16 highlights and the full year 2016 guidance.
Source: Realty Income Website
For 2016, the company is expecting about 3% growth in FFO and 5% in Adjusted FFO (AFFO). Those numbers represent good solid growth and should allow for continued increases in the dividend in 2016. But, at that growth rate, it would take a couple of years to “grow into” the current valuation.
I’ve always managed in the past to buy Realty Income at a yield valuation of 5% or better and, with patience, I believe I’ll have the opportunity again. I recently published another article on Sure Dividend that looked at different strategies for maximizing returns based on entry valuations. Part of that article discussed typical stock volatility and how to benefit from that volatility. Readers can view the complete article here. With Realty Income, I’ve frequently benefited from “buying the dips”.
What Are The Risks Of An Investment in Realty Income?
The primary risk is the potential for interest rates to rise significantly. Realty Income is primarily an income investment with medium growth and a significant dividend yield. It therefore falls into the category of bond surrogate and will likely see its share price fall if interest rates begin to rise.
Because Realty Income is able and expected to grow along with the economy, a fall in Realty Income’s valuation due to rising interest rates would likely be temporary.
The second impact of a rising rate environment would be an increase in borrowing costs to continue to grow its real estate footprint.
That said, I don’t expect the US Federal Reserve will make any significant move to raise interest rates. It is an election year, the US economy is soft, the employment metrics have turned down over the last couple of months, and the rest of the world is still trying to juice their economies via loose monetary policy. If there is to be an increase in the Federal Funds Rate in June, I expect it will be a small one.
Conclusion
Realty Income Corp (NYSE:O) is a great company and has a tremendous following.
Based on its historical performance, conservative management, and solid balance sheet, I expect it will continue to do well in the future.
I introduced this article as well as the prior three articles on the premise that I would list the “Best of the Best” monthly dividend paying stocks in the order of most undervalued to least. That I am listing Realty Income fourth out of four does not mean I believe its potential is less than STAG, CLDT, or LTC.
It is simply that I consider Realty Income’s valuation to be high at this time and recommend waiting for a better opportunity to buy into the company.
Disclosure: This article was originally published on Sure Dividend by Dirk S. Leach.
