REITs on the radar: Realty Income Corp

What Makes Realty Income (O) a Good Business?

Realty Income is a Real Estate Income Trust (REIT) operating mainly in the retail business (79.5% of rental income) along with a small diversification in industrial and office businesses. The company focuses on acquiring freestanding, single-tenant properties under long-term, net lease agreements. It has built the bulk of their business through purchasing Real Estate from potential client to lease them back to them.

Realty Income owns over 4,900 properties with 47 different lines of businesses. Their three largest segments of business in term of rental income are Drug Stores (11.1%), Convenience Stores (9.9%) and Dollar Stores (8.0%). Their three most important states are Texas (9.7%), California (9.4%) and Florida (5.9%).

Revenue

Revenue Graph from Ycharts

As you can see, O is on a solid streak for growth since 2012. The company is using a growth by acquisition strategy and has been increasing its asset size by $9.3 billions since 2010 with $1.86 billions acquisition in 2016. Management still has access to a $2 billion acquisition credit facility for future purchases. While the 2013-2017 growth trend is unsustainable, you can expect O to continue showing stronger revenues in the upcoming years.

How O fares vs My 7 Principles of Investing

We all have our methods for analyzing a company. Over the years of trading, I’ve been through several stock research methodologies from various sources. This is how I came up with my 7 investing principles of dividend investing. Let’s take a closer look at them.

Source: Ycharts

Principle #1: High Dividend Yield Doesn’t Equal High Returns

My first investment principle goes against many income seeking investors’ rule: I try to avoid most companies with a dividend yield over 5%. Very few investments like this will be made in my case (you can read my case against high dividend yield here). The reason is simple; when a company pays a high dividend, it’s because the market thinks it’s a risky investment… or that the company has nothing else but a constant cash flow to offer its investors. However, high yield hardly come with dividend growth and this is what I am seeking most.

Source: Data from Ycharts.

Realty Income has maintained a relatively high yield since 2012, but nothing seems out of control. In fact, the recent stock price rise since 2014 brought the dividend yield below the 5% level while the dividend payment continued to raise.

O meets my 1st investing principles.

Principle #2: Focus on Dividend Growth

Speaking of which, my second investing principle relates to dividend growth as being the most important metric of all. It proves management’s trust in the company’s future and is also a good sign of a sound business model. Over time, a dividend payment cannot be increased if the company is unable to increase its earnings. Steady earnings can’t be derived from anything else but increasing revenue. Who doesn’t want to own a company that shows rising revenues and earnings?

Source: Ycharts

O shows an impressive track record of almost 47 years with dividend payments along with 21 consecutives years with a dividend increase. During this period, O is showing a compound average annual growth rate of 4.7%. This is more than enough to beat inflation. Another nice feature for income seeking investors is that O pays its dividend on a monthly basis making it easier to manage one’s budget.

O meets my 2nd investing principle.

Principle #3: Find Sustainable Dividend Growth Stocks

Past dividend growth history is always interesting and tells you a lot about what happened with a company. As investors, we are more concerned about the future than the past. this is why it is important to find companies that will be able to sustain their dividend growth.

Source: data from Ycharts.

It is a little bit more different to analyse REIT than other stocks. While I consider the payout and cash payout ratio for other companies, I must focus on FFO (funds from operations) and AFFO payout ratios. The first graph shows you that management makes a good job raising the dividend according to the FFO trend.

The following graph has been created from O 2016 financial statements. It shows that their payout ratios are not only under control, but they are both decreasing from 92% and 91% in 2009 to 83% for both ratios in 2016.

O meets my 3rd investing principle.

Principle #4: The Business Model Ensure Future Growth

I like Realty Income diversification model where management leaves very little room for uncertainty. Their top 20 tenants represent 53% of their rental income spread across 11 different industries. It also shows a steady occupancy rate in the 98’s with a 99% recapture of expiring rents rate since 1996.

Beyond the REIT diversification, I like its growth by acquisition strategy ensuring higher revenues and dividend payment over time even more. O has developed a strong expertise in growing their property portfolio on a steady and sustainable manner. Through this strategy, they roughly double the number of property owned every 10 years.

Finally, the big talk about the retail REIT industry right now is all about finding ecommerce resilient tenants. We are very aware of classic stores such as Walmart (WMT) and Target (TGT) growth challenges by Amazon (AMZN) of this world. In this category, O is making an effort and shows an interesting mix of tenants. This is not the most ecommerce proof REIT I’ve seen (NNN is definitely ahead in this category), but it still makes good figures.

O still shows a strong business model and meets my 4th investing principle.

Principle #5: Buy When You Have Money in Hand – At The Right Valuation

I think the perfect timing to buy stocks is when you have money. Sleeping money is always a bad investment. However, it doesn’t mean that you should buy everything you see because you have some savings aside. There is a valuation work to be done. In order to achieve this task, I will start by looking at how the stock market valued the stock over the past 10 years by looking at its PE ratio:

Source: data from Ycharts.

While the PE ratio is not exactly the best metrics to evaluate a REIT, you can see how it makes little sense to purchase a stock at a 50 multiplier. The stock price seems high considering its historical valuation.

Digging deeper into this stock valuation, I will use a double stage dividend discount model. As a dividend growth investor, I rather see companies like big money-making machine and assess their value as such. I used a 4.5% dividend growth rate for the first 10 years which is in line with the company history growth rate.  As the business will have a hard time continue growing at the past 4 years pace, I expect the terminal growth rate to reduce to 4%.

Here are the details of my calculations:

Source: Dividend Monk Toolkit Excel Calculation Spreadsheet

As we often see on the market, there is a price to pay for quality stocks. This seems to be the case for O as both valuation methods show it is currently overvalued.

O DOES NOT my 5th investing principle with a potential upside of 33%

Principle #6: The Rationale Used to Buy is Also Used to Sell

I’ve found that one of the biggest investor struggles is to know when to buy and sell his holdings. I use a very simple, but very effective rule to overcome my emotions when it is the time to pull the trigger. My investment decisions are motivated by the fact that the company confirms or not my investment thesis. Once the reasons (my investment thesis) why I purchase shares of a company  are not valid anymore, I sell and never look back.

Investment thesis

While O is currently overvalued according to our model, an investment in this company today still makes sense. If you are looking for a steady high yielder in your portfolio, an investment in O makes total sense. You will benefit from a company that is geographically diversified and that has focused on tenants with limited exposure to ecommerce threats.

Realty Income shows a stellar dividend growth history leading me to think the payout will continue to increase in the rage of 4% to 4.5% each year for several years to come. O seems a great fit for any income seeking investors.

O shows a solid investment thesis and meet my 6th investing principle.

Principle #7: Think Core, Think Growth

My investing strategy is divided into two segments: the core portfolio built with strong & stable stocks meeting all our requirements. The second part is called the “dividend growth stock addition” where I may ignore one of the metrics mentioned in principles #1 to #5 for a greater upside potential (e.g. riskier pick as well).

When you purchase a REIT, you don’t expect its stock price to compete against AAPL growth. Realty Income does use a growth by acquisition strategy to generate value for its shareholders but don’t expect the stock price to soar anytime soon, especially with the current valuation. However, you can expect O to pay a better yield than most bonds with a nice increase each year.

O is a core holding.

Final Thoughts on O – Buy, Hold or Sell?

In the light of my analysis, I conclude that O is a very interesting company but not at this valuation. I think that if you are in the search for additional income in your portfolio, it should be on your watch list, but you could certainly benefit from a better entry point in the future.

 

Disclaimer: I do not hold O in my DividendStocksRock portfolios but intend to purchase the stock.

The opinions and the strategies of the author are not intended to ever be a recommendation to buy or sell a security. The strategy the author uses has worked for him and it is for you to decide if it could benefit your financial future. Please remember to do your own research and know your risk tolerance.

QUALCOMM (QCOM) is a BUY

Qualcomm has been on my radar for a while now. More recently, a legal lawsuit coming from Apple (AAPL) made QCOM stock price drop by over 10% since the beginning of the year. It seems a great entry point for any investors looking to had a techno dividend paying company.

Business model:

Qualcomm Inc develops digital communication technology called CDMA (Code Division Multiple Access), & owns intellectual property applicable to products that implement any version of CDMA including patents, patent applications & trade secrets. The company derived most of its income from the smartphone business selling chips for power and network connectivity.

Main strengths:

QCOM rides naturally on the smartphone wave as 90% of its revenues is derived from this industry as it drives royalty from 3G and 4G utilization. We see another great year for the smartphone industry in 2017, therefore, Qualcomm should continue to benefit from this profitable business niche. QCOM has implemented both buybacks and dividend payment increases at the same time.

Potential risks:

On top of China, other governments are eyeing QCOM business model under the anti-monopoly regulations. This could hurt future royalty earnings and therefore reduce QCOM growth potential. QCOM owns near to a monopoly in CDMA technology patent which is why it can charge such high royalty fee (3-5%). Worst case scenarios include a diminution of royalty fees which would affect QCOM future earnings growth.

Dividend growth perspective:

QCOM business model benefits from very strong royalty generated through patents. Those patents will generate strong cash flow for the next decade to come. This money will definitely results in additional dividend increase in the future. The company has a great window to find other opportunities while it enjoys its royalties. The dividend payment should continue to grow steadily in the upcoming years.

Investment thesis:

As we believe royalties will continue to bring in the dough for a decade, QCOM is sitting on a sustainable business model giving it the possibility to grow even bigger. In 2016, the company has gained strong momentum on the stock market and we believe this uptrend will persist in 2017. Its strong relationships with smartphone makers gives QCOM an edge about what is coming in the newest technology needs. You can bet QCOM will also own patents in the future mobile industry.

Valuation:

Source:Dividend Monk Toolkit Excel Calculation Spreadsheet

I’ve used the double stage dividend discount model to determine QCOM fair value. I believe in the strong potential of the company and the DDM shows there is a clear opportunity at the moment. Once the legal lawsuit with Apple (AAPL) is resolved, QCOM could rise again.

disclaimer: Long AAPL, no position in QCOM yet.

How many trades should I make a year?

Is there a specific amount of trades an investor should make each year?

Interesting enough, I’ve been called a “trader” from time to time while I define myself as a dividend growth investor. Which type of investor suits me best? I would definitely vote for dividend growth investor, but I will also admit I trade a lot more than the classic dividend investor.

For many, the number of trades you make in a month or a year often define the type of investor you are. If you trade on a daily basis, you are most probably a penny stock trader or a technical analysis fan. If you trade on a monthly basis, you are an active investor, read trader. If you rarely sell any of your holding throughout years, then you can qualify as a buy & hold investor or a dividend growth investor.

I’m having a hard time with these definitions linked to the number of trades completed. In my opinion, there isn’t a minimum or maximum amount of trades you should complete each year. It all depends on where you are at with your portfolio and your investing strategy.

If you are like me and you have decided to divide your portfolio into two sections (core and growth), you will most likely sell one of your holding every year or two. My “growth portfolio” includes companies that I believe are undervalued for a specific reason. These trades are usually more volatile and include a higher degree of risk. In the past, I bought Seagate Technology (STX) while they were in the middle of a growth crisis doubled with a major flood affecting their production capacity. I also bought Apple (AAPL) before the company split as many experts thought their iPhone was about to die (that was before iPhone5… imagine!). Finally, I bought SNC Lavalin (SNC.TO) as the engineering firm was in the middle of a fraud scandal and was brought to justice by the Canadian Government. These are examples of timely trades where I might now keep these companies forever. My investing horizon for such holdings is 18 to 24 months. This is why I will most likely sell one company in my portfolio each year or two.

On the other hand, the core of my portfolio is built with a long term holding horizon in order to benefit from the full potential of compounding dividend growth. These companies are selected upon the 7 dividend investing principles and will most likely be part of my nest egg forever. However, as I previously mentioned, I still follow each of my holdings closely on a quarterly basis to make sure they all continue to show the following criteria:

  • Dividend payment growing each year
  • Payout ratios under control
  • Company is a leader in its market
  • Revenue and earnings on a growing trend
  • Company showing clear competitive advantages

These are key factors to ensure dividend growth over a long period. If a company ends-up failing to meet these criteria or doesn’t meet my investment thesis fundamentals anymore, I will pull the trigger and sell it. I’m not just content about receiving decent dividend income, I want each company I own to be prosperous and grow in value. As the economic environment changes rapidly, it is very possible that a company shows great characteristics today yet loses steam over the years. Some of them just hit a speedbump and are already working on solutions while others can’t find a way to get back on track.

Don’t become trigger happy, but don’t be too complacent

There is a thin line between becoming trigger happy and selling any company that fails to produce growth every quarterly report and being too lenient with management. As much as I want to make sure that each company I hold generates ever growing profits, I can also understand that the economy goes through cycles and there will be poor quarters in any type of industry. The idea is to be able to analyze why there are poor results and to look at what management is putting in place to get back on track.

Making too many trades will only increase your trading fees and reduce your dividend growth potential. Not making any trades could lead to you holding bad companies rotting your total return. There is a balance to reach between the two approaches and this is not easy. I guess the solution is not to determine an ideal number of trades to achieve each year. If you must sell 2 of your holdings during a bad year, so be it. Just make sure you don’t do it out of panic or lack of patience. Always review your investment thesis before pulling the trigger. As long as a company meets the reasons why you selected it in the first place, you should not be in a hurry to sell it.