If there’s anything more exciting than investing, I don’t know of it.
Investing is something that can be almost anything to almost anyone.
It can be a hobby, a career, or a lifetime journey of self-improvement.
That last option is possible because investing touches almost every aspect of life, from finances to business to politics to human psychology.
Getting better, through exposure and practice, across multiple disciplines is incredibly helpful and satisfying.
Of course, the building of lots of wealth and passive income over time doesn’t hurt, either.
And when it comes to that, I believe the best investment strategy toward this end is dividend growth investing.
This is a long-term investment strategy that prioritizes buying and holding shares in high-quality businesses that reward their shareholders with steadily rising cash dividends.
You can find many businesses that qualify for the strategy by pulling up the Dividend Champions, Contenders, and Challengers list.
This list has put together a treasure trove of data on hundreds of US-listed stocks that have raised dividends each year for at least the last five consecutive years.
What you’ll notice on this list is a common theme of quality.
After all, it takes a great business to be able to consistently generate the ever-more profit in order to afford the ability to pay out ever-larger dividends to shareholders.
This quality filter makes the strategy highly effective.
And being able to reinvest growing dividends back into more businesses paying growing dividends creates this unstoppable force driving one toward immense wealth and passive income, along with freedom.
I’ve experienced this personally, using the strategy to guide me as I’ve gone about building the FIRE Fund.
That’s my real-money portfolio, and it produces enough five-figure passive dividend income for me to live off of.
I’ve been able to live off of this passive income since I retired in my early 30s.
By the way, if you’re curious how an early retirement like that is possible, make sure to read my Early Retirement Blueprint.
Now, the strategy involves more than simply investing in the right businesses (although that is incredibly important).
There’s also the matter of investing at the right valuations.
Whereas price represents what you pay, value represents what you actually get.
An undervalued dividend growth stock should provide a higher yield, greater long-term total return potential, and reduced risk.
This is relative to what the same stock might otherwise provide if it were fairly valued or overvalued.
Price and yield are inversely correlated. All else equal, a lower price will result in a higher yield.
That higher yield correlates to greater long-term total return potential.
This is because total return is simply the total income earned from an investment – capital gain plus investment income – over a period of time.
Prospective investment income is boosted by the higher yield.
But capital gain is also given a possible boost via the “upside” between a lower price paid and higher estimated intrinsic value.
And that’s on top of whatever capital gain would ordinarily come about as a quality company naturally becomes worth more over time.
These dynamics should reduce risk.
Undervaluation introduces a margin of safety.
This is a “buffer” that protects the investor against unforeseen issues that could detrimentally lessen a company’s fair value.
It’s protection against the possible downside.
Using investing to your advantage – in every capacity possible – can totally transform your life, especially if you specifically apply the dividend growth investing strategy by continually buying undervalued high-quality dividend growth stocks.
The preceding passage on valuation is, of course, only useful if one already understands how valuation works.
If you don’t yet have that understanding in place, Lesson 11: Valuation has you covered.
Written by fellow contributor Dave Van Knapp, it explicitly describes the ins and outs of valuation and even provides an easy-to-follow valuation template that you can easily use on your own.
With all of this in mind, let’s take a look at a high-quality dividend growth stock that appears to be undervalued right now…
Realty Income Corp. (O)
Realty Income Corp. (O) is a real estate investment trust that primarily leases freestanding, single tenant, triple-net-leased retail properties.
Founded in 1969, it’s now a $51 billion (by market cap) real estate titan that employs approximately 500 people.
Realty Income’s property portfolio of over 15,000 properties is diversified across the US, Puerto Rico, and parts of Western Europe.
The company serves more than 1,500 clients operating across nearly 90 different industries.
The property portfolio has an occupancy rate of 98.7%.
Almost 80% of the properties are retail by type, while the remainder is mostly industrial.
No one tenant comprises more than 3.5% of annualized contractual rent.
Due to favorable long-term supply-demand dynamics, real estate can be quite lucrative.
First, there’s the supply side.
The old adage about land goes like this: “They’re not making it anymore”.
The finite nature of available land means there’s a scarcity when it comes to how much real estate can possibly be built (because buildings have to be built on something).
Plus, building out physical real estate requires heavy upfront investments (including both capital and time).
With limitations, supply is constrained.
Second, there’s the demand side.
Human beings must live in and interact with the physical world, leading to built-in demand for real estate.
We live, go to work, store, and shop in physical buildings.
Realty Income capitalizes on this inherently favorable supply-demand situation by erecting profitable properties on valuable tracts of prized land.
If you can put up well-located property, and then you’re able to rent it out to a viable tenant, you have yourself a cash cow.
That’s great.
But what Realty Income has done is, they’ve repeated that process more than 15,000 times.
In doing so, the REIT has amassed a large and diversified portfolio of 15,000+ individual cash cows that collectively comprise the $50+ billion enterprise.
And the joy of simply buying shares in Realty Income takes all of the hard work out of the equation.
Becoming a landlord on your own involves scouting, studying comps, lining up financing, leverage, closing, finding tenants, managing property, etc.
And that’s just one property.
Imagine doing that over and over again.
Why bother with that when buying shares of Realty Income and gaining a slice of ownership of a large portfolio of thousands of commercial properties with paying tenants already installed is a far easier way to go.
Buying those shares means one instantly becomes a scaled-up “landlord” – with none of the associated headaches.
Just sit back and collect your rent dividends.
What’s especially powerful about Realty Income’s business model is that it largely employs commercial triple-net leases on its properties.
This is a lease agreement on a property in which the tenant agrees to pay all of the expenses of the property, including real estate taxes, building insurance, and maintenance.
This passes on a lot of costs to tenants and minimizes Realty Income’s overhead.
Speaking of tenants, Realty Income has some of the biggest and best ones out there already installed.
Top tenants include the likes of FedEx and Life Time Fitness.
Most of the Realty Income’s properties are designed for everyday consumer usage and convenience, such as convenience stores, grocery stores, gyms, and pharmacies.
A durable desire for convenience, and the small, repeated visits/purchases that stem from it, protects the company against e-commerce encroachment.
Realty Income’s capitalization on favorable supply-demand dynamics in real estate by building out an empire of CRE properties featuring advantageous leasing structure sets it up to continue growing its revenue, profit, and dividend for years and years into the future.
Dividend Growth, Growth Rate, Payout Ratio and Yield
To this point, Realty Income has increased its dividend for 32 consecutive years already.
What this track record does is, it qualifies Realty Income as a Dividend Aristocrat – one of only a few REITs that can claim such a feat.
The company takes pride in its ability to consistently deliver dependable and growing dividends to shareholders.
In fact, this is part of the company’s official mission: “To invest in people and places to deliver dependable monthly dividends that increase over time.”
Can’t not like that.
The 10-year dividend growth rate is 3.6%.
Decent.
Certainly beats inflation, although growth-oriented investors may balk at the lower growth rate.
However, for older, income-oriented investors, the stock’s yield of 5.7% is appealing and likely makes up for the lower growth rate.
REITs are legally obligated to pay out at least 90% of taxable income in the form of dividends, which is why REITs can be great option for income-seeking investors.
This market-smashing yield, by the way, is 90 basis points higher than its own five-year average.
That makes the current yield especially appealing right now.
Adding to the appeal is the fact that Realty Income pays its dividend monthly.
This gives the dividend a synthetic “monthly rent check” feel that is satisfying.
Realty Income takes its role as a monthly dividend payer so seriously that it has trademarked its infamous moniker: The Monthly Dividend Company®.
Again, how can you not like this?
Based on midpoint AFFO/share guidance for FY 2025, the payout ratio is 75.8%.
This is roughly in line with Realty Income’s recent history.
A mid-70% payout ratio is fairly common and reasonable for a REIT, indicating dividend sustainability.
Said another way, I see no issues with Realty Income’s ability to continue living up to expectations as one of the most reliable dividend payers in the world.
For those interested in living off of dividends, this reliability (after all, bills are very reliable) is almost priceless.
Realty Income’s reputation as a dividend stalwart is fully intact, making the idea of owning the stock (for income-seeking investors, particularly) as compelling as ever.
Revenue and Earnings Growth
As compelling as it may be, though, a lot of the dividend metrics shown above are looking backward.
However, investors must always be looking forward, as the capital of today is ultimately risked for the rewards of tomorrow.
Thus, I’ll now build out a forward-looking growth trajectory for the business, which will be of aid when the time comes later to estimate intrinsic value.
I’ll first show you what the business has done over the last decade in terms of its top-line and bottom-line growth.
And I’ll then reveal a professional prognostication for near-term profit growth.
Amalgamating the proven past with a future forecast in this way should give us the details we need to construct a model that determines where the business could be going from here.
Realty Income advanced its revenue from $1 billion in FY 2015 to $5.3 billion in FY 2024.
That’s a compound annual growth rate of 20.4%.
Excellent top-line growth, which is unexpected out of a slow-growth REIT.
But it’s also extremely misleading.
Realty Income has been highly acquisitive over the last decade.
A prime example is Realty Income merger with former competitor VEREIT in 2021 (the cost of which was the equivalent of ~$11 billion), which substantially increased revenue.
The 2023 acquisition of Spirit Realty Capital in all-stock deal worth $9.3 billion is another example.
There’s also the matter of dilution.
REITs fund growth via debt and equity issuances.
With a REIT, it’s imperative to look at profit growth on a per-share basis.
And when assessing profit for a REIT, you want to use funds from operations (or adjusted funds from operations) instead of normal earnings.
FFO is a measure of cash generated by a REIT, which adds depreciation and amortization expenses back to earnings.
FFO/share for Realty Income grew from $2.77 to $4.01 over this period, which is a CAGR of 4.2%.
There you go.
You can clearly see the massive discrepancy between top-line and bottom-line growth, largely owed to an outstanding share count that has more than tripled over the last decade and brutally diluted existing shareholders.
That latter growth rate is the far more accurate one of the two, and I think it’s a pretty realistic representation of Realty Income’s true growth profile (which is one of mid-single-digit growth).
We can see that this is pretty close to (albeit slightly higher than) the 10-year dividend growth rate, providing further evidence of this being in the right ballpark of what Realty Income is likely capable of over time.
Looking forward, CFRA currently has no three-year forecast for Realty Income’s FFO/share growth.
This is unfortunate, as I do like to compare the proven past with a future forecast in order to better model out a growth trajectory.
However, it seems that CFRA often omits this forecast for REITs.
Nonetheless, CFRA is generally optimistic on Realty Income’s longer-term pathway, noting: “[Realty Income] has a long history of high occupancy rates, along with stable, growing dividend payments, that give us confidence in its ability to weather a variety of macro environments.”
Really couldn’t agree more.
In addition, as I just illuminated, we have a clear trend of mid-single-digit bottom-line and dividend growth from Realty Income, which I think negates the need for some deep insight into where Realty Income may be going.
Realty Income has been growing at somewhere between 3% and 5% per year for as long as I’ve been investing, and I don’t see anything to indicate that the growth engine is accelerating or decelerating in any meaningful way.
On one hand, Realty Income’s absolute size is a hindrance to relative growth.
On the other hand, management has entered new markets – both in the geographic sense (including expanding into Western Europe) and the real estate type sense (diversifying into data centers and gaming properties).
The diversification and growth efforts are new and make up a small part of the overall pie, but the global opportunity set for Realty Income is not small.
If we zoom into very recent results, Realty Income produced 4% YOY AFFO/share growth for Q4 FY 2024, and AFFO/share for the whole of FY 2024 was 4.8% higher YOY.
And only days ago, Realty Income reported 2.9% YOY AFFO/share growth for Q1 FY 2025.
Those numbers are right in the 3% to 5% range I just pointed out.
Splitting the difference and coming right down the middle puts one at 4%/year growth on the dividend, which I think is a reasonable expectation to have.
Some years might be a bit lower, and we might see other years come in a bit higher.
But that’s where I come in at on Realty Income.
And when you’re starting off with a starting yield of nearly 6% – and this dividend is paid monthly – I think that’s a very acceptable level of growth to have, particularly if one is older and interested in living off of dividends.
Balancing things out, it’s a nice total dividend package.
Financial Position
Moving over to the balance sheet, Realty Income has a good financial position.
The company’s credit ratings are well into investment-grade territory: A3, Moody’s; A-, S&P Global.
Moreover, many of Realty Income’s top tenants have investment-grade credit ratings of their own.
A common measure for a REIT’s financial position is the debt/EBITDA ratio.
Most of the REITs I’ve come across tend to be in a range between 3 and 7 on this ratio.
Realty Income finished last fiscal year with a net debt/pro forma adjusted EBITDAre ratio of 5.4.
This would put Realty Income somewhere in the middle of the pack, meaning its neither excellent nor terrible.
Realty Income’s management has shown an ability to prudently allocate capital and manage the finances at scale, so I’m personally unconcerned by the balance sheet.
Overall, what we have here is one of the world’s largest and finest commercial real estate empires.
Combining triple-net leases with a diversified roster of top tenants across varied real estate types is a simple approach that has led to one of the best long-term track records in the entire commercial real estate space.
And with massive scale, deep industry expertise, and long-term contracts locking in tenants, the company does benefit from durable competitive advantages.
Of course, there are risks to consider.
Litigation, regulation, and competition are omnipresent risks in every industry.
Real estate demand is inherently cyclical, and any kind of recession could impact Realty Income’s tenants, which could then impact Realty Income itself.
The capital structure of a REIT relies on external funding for growth (because most of the income is paid out to shareholders in the form of dividends), resulting in debt and equity issuances, which exposes the company to volatile capital markets and interest rates.
Elevated interest rates can hurt the company twice over: Debt becomes more expensive (through higher servicing costs), and equity can also become more expensive (because income-sensitive investors have alternatives, which can reduce demand for and pricing on the stock).
A recession can also hurt the company twice over: Demand for commercial real estate can cool, and equity issuances after a presumed drop in the stock’s price would come at a higher cost.
Realty Income is heavily tied to retail, which exposes the firm to various headwinds in this space (such as the rise of e-commerce, as well as physical retail theft).
The company’s scale is an advantage, but it also introduces concerns regarding the REIT’s size and how the law of large numbers may start to harm growth.
There are certainly some risks present, but I think Realty Income’s quality and consistent track record helps to overcome worries.
And the valuation, which is very undemanding, also helps to overcome concerns…
Valuation
The stock is available for a forward P/FFO ratio of 13.4, based on FY 2025 AFFO guidance.
Seeing as how this is roughly analogous to a P/E ratio on a non-REIT stock, it’s easy to see how modest this is.
The P/CF ratio is 13.9.
This is low both in absolute and relative terms, being not high at all and also well below its own five-year average of 16.2.
And the yield, as noted earlier, is significantly higher than its own recent historical average.
So the stock looks cheap when looking at basic valuation metrics. But how cheap might it be? What would a rational estimate of intrinsic value look like?
I valued shares using a dividend discount model analysis.
I factored in a 10% discount rate and a long-term dividend growth rate of 4%.
If you’ve been following along, this 4% growth rate would come across as obvious.
Everything lines up well for this number.
It’s close to both the dividend and FFO/share growth demonstrated over the last decade, along with more recent growth out of the REIT.
Again, this splits the difference and comes right between the 3% and 5% growth rate I discussed earlier.
I’d be surprised to see Realty Income grow much faster than 4%, and I’d be equally surprised to see it grow much slower.
This is, in my view, a realistic expectation for dividend growth out of the firm over the coming years.
The DDM analysis gives me a fair value of $55.81.
The reason I use a dividend discount model analysis is because a business is ultimately equal to the sum of all the future cash flow it can provide.
The DDM analysis is a tailored version of the discounted cash flow model analysis, as it simply substitutes dividends and dividend growth for cash flow and growth.
It then discounts those future dividends back to the present day, to account for the time value of money since a dollar tomorrow is not worth the same amount as a dollar today.
I find it to be a fairly accurate way to value dividend growth stocks.
Based on how I’m viewing the stock, it looks, at worst, fairly valued to me.
But we’ll now compare that valuation with where two professional stock analysis firms have come out at.
This adds balance, depth, and perspective to our conclusion.
Morningstar, a leading and well-respected stock analysis firm, rates stocks on a 5-star system.
1 star would mean a stock is substantially overvalued; 5 stars would mean a stock is substantially undervalued. 3 stars would indicate roughly fair value.
Morningstar rates O as a 5-star stock, with a fair value estimate of $75.00.
CFRA is another professional analysis firm, and I like to compare my valuation opinion to theirs to see if I’m out of line.
They similarly rate stocks on a 1-5 star scale, with 1 star meaning a stock is a strong sell and 5 stars meaning a stock is a strong buy. 3 stars is a hold.
CFRA rates O as a 3-star “HOLD”, with a 12-month target price of $60.00.
I’m definitely on the low end this time around. Averaging the three numbers out gives us a final valuation of $63.60, which would indicate the stock is possibly 10% undervalued.
Bottom line: Realty Income Corp. (O) operates a commercial real estate empire, leveraging the power of triple net leases on quality tenants. It pays a monthly dividend, offering investors a synthetic “monthly rent check” without any of the associated hard work. With a market-smashing yield, inflation-beating dividend growth, a sustainable payout ratio, more than 30 consecutive years of dividend increases, and the potential that shares are 10% undervalued, this Dividend Aristocrat could be perfectly suited for income-leaning dividend growth investors.
-Jason Fieber
Note from D&I: How safe is O’s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 80. Dividend Safety Scores range from 0 to 100. A score of 50 is average, 75 or higher is excellent, and 25 or lower is weak. With this in mind, O’s dividend appears Safe with an unlikely risk of being cut. Learn more about Dividend Safety Scores here.
P.S. If you’d like access to my entire six-figure dividend growth stock portfolio, as well as stock trades I make with my own money, I’ve made all of that available exclusively through Patreon.
Disclosure: I’m long O.
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