In my view, Realty Income (NYSE:O) is a terrific dividend stock. It’s one of the largest holdings in my portfolio.
If I’d invested £1,000 in the stock 10 years ago, I’d have an investment worth £3,417 at today’s prices. That’s an average compounded annual return of 13%, which I think is pretty good.
In addition, I’d be earning around £156 per year in dividends. That’s genuine passive income – a 15% return on my original investment for doing absolutely nothing.
Realty Income
Realty Income makes money by owning and leasing retail properties. As a REIT, the company distributes 90% of its rental income to shareholders in the form of dividends.
Like a lot of dividend stocks, the company’s share price is propelled by the dividends it pays out. Ten years ago, the stock traded at around $39, meaning that £1,000 would have bought me 41 shares.
Since then the company’s dividend has grown by just over 5% per year on average. And the share price has increased by roughly the same amount.
Over the last decade, the business has distributed a total of $25.47 per share in dividends. While share prices have fluctuated, reinvesting those would have increased my share count to 65.
In other words, I’d own 59% more shares in a company that had grown by around 5% per year. Along with a shift in the value of the dollar against the pound, this accounts for the 13% annual return.
Dividend stocks
I see Realty Income as a demonstration of the returns a good dividend stock can offer a patient investor. But what does the future look like for the company?
If the stock continues to average 13% annual returns for another 20 years, then a £1,000 investment from a decade ago will be worth £39,000. That’s pretty staggering, but I don’t think it will happen.
The main way for Realty Income to grow is by adding properties to its portfolio. But growing in this way is more difficult now than it was a decade ago.
There are two reasons for this. First, interest rates are around 3.78% today, compared to 0.16% 10 years ago.
As a REIT, Realty Income can’t retain earnings in order to grow. That means it has to raise capital by borrowing and higher interest rates make this more expensive.
Second, the company is much bigger than it was a decade ago. Revenues over the last 12 months are around $3.1bn, compared to $458m in 2012.
AS a result, the company has to target bigger acquisitions to achieve meaningful growth. Revenue growth of 5% now requires an additional $155m, rather than $22m.
A stock to buy
I’m therefore not expecting 13% annual returns from the company going forward. But I’m still buying Realty Income stock for my portfolio.
Warren Buffett says it’s better to buy a quality company offering a lower return than to take risks chasing a bigger payoff. That’s exactly my approach here.
Even though I think returns will be lower than they have been, I still expect a consistently above-average return going forward.
