Investors have soured on the stock due to its sliding share price. There’s some irony there.
Investors who strive for a specific investment return should love dividends because they are concrete returns you can’t lose once paid. For example, suppose you want to earn 10% on a stock you own for a year. If that stock pays a dividend yielding 5%, you’re already halfway to your goal!
You can rest easier knowing you have something to show for your investment and aren’t entirely at the mercy of Wall Street’s (often irrational) volatility.
Realty Income (O 0.74%) is a well-known dividend stock. It’s famous for paying a rare monthly dividend and continually increasing the amount it pays. The company has raised its dividend for 31 consecutive years and counting.
You may have overlooked Realty Income recently. Shares have fallen 24% over the past five years.
Pay attention. I’ll show you how powerful dividend stocks like Realty Income can be and why the stock is a wonderful buy today.
Do dividends matter? More than you realize
Realty Income is a real estate investment trust, or REIT. It’s a company that acquires and leases real estate. In other words, it’s like a landlord you can invest in, so that you can enjoy the cash flow real estate earns without buying buildings. Realty Income specializes in single-tenant retail properties, where one tenant, generally a consumer-facing business like a movie theater, convenience store, or gas station, rents the building.
REITs must pay at least 90% of their taxable income as dividends, so companies like Realty Income make great dividend stocks. Realty Income’s dividend yield is approximately 6% at its current share price. Now, I get it. Nobody wants to be down 24% after five years. But the truth is that Realty Income’s dividend has helped soften that blow quite a bit.
While the stock price is down 24% after five years, the stock’s total return, including dividends, has investors close to break-even.
O data by YCharts
To be fair to Realty Income, things have worked against the company these past five years. Real estate companies faced a generational crisis in COVID-19. Additionally, interest rates have surged higher. That’s a problem for REITs because they rely heavily on borrowing to fund new property acquisitions. Realty Income has gotten a bad rap, primarily due to bad luck.
Ready to melt your mind? Zoom out further and see how big a difference dividends make over time. Realty Income has badly trailed the S&P 500 on price appreciation after decades, but it handily outperforms with dividends.
O Total Return Price data by YCharts
Realty Income’s share price declines get all the attention. Ironically, the dividends created big returns over time. Again, Realty Income’s stock is down due to bad luck (pandemic and high rates), not because it’s a bad business.
Why is the stock poised for a comeback?
I suspect that Realty Income will eventually bounce back. For starters, the dividend, the most crucial aspect of the stock, is rock-solid. Analysts believe Realty Income will earn $4.22 per share this year. That is a dividend payout ratio of just 75% based on its annualized dividend per share.
Meanwhile, many expect interest rates across the U.S. economy to fall over time. The FOMC, which controls the primary interest rate in the economy, has been looking for inflation to come down, and recent data points to precisely that happening. Lower rates mean cheaper borrowing, which is a tailwind for REITs like Realty Income.
Realty Income stock now yields near its decade-high, and its price versus its cash flow is near its decade-low. That means the stock is cheap, and analysts still see Realty Income growing its distributable cash (profits for REITs) at a low-single-digit rate annually. Investors are looking at potential double-digit total returns when combining dividends and growth. A potentially higher valuation is just a bonus.
O Price to Free Cash Flow data by YCharts
Remember, stocks like Realty Income can make you rich with their dividends. It just might take time. Investors should have no concerns over the dividend moving forward, and the stock’s potential rebound is more icing on the cake than the main course.
Situations like this are how long-term investors win.
Justin Pope has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Realty Income. The Motley Fool has a disclosure policy.