It's hard to find high dividend yields you can trust. Remember, a stock's dividend yield is a ratio of the company's declared payout to its share price. So, a high yield can signal that a stock is risky when the market won't support a higher share price. But that's not always the case. Realty Income (O -0.77%) is a prime example.
By design, this well-known real estate investment trust (REIT) (and every other REIT) distributes most of its income to shareholders. That said, the stock is struggling. Shares are trading near their 52-week low, pushing the yield to 6%.
But sometimes, a stock's struggle is more due to external factors than the underlying business. Today, I think that's the case. I'll highlight what might be dragging Realty Income's stock down and why this is potentially one of the best dividend stock opportunities heading into 2025.
Interest rate woes are keeping Realty Income down
Realty Income and other REITs are companies that acquire and lease real estate. Realty Income specializes in leasing single-tenant retail properties using net leases. Its core tenant base includes recession-resistant businesses, like convenience stores, grocery stores, dollar stores, pharmacies, and restaurants. A REIT doesn't pay corporate income taxes because it distributes at least 90% of its income to shareholders. That's why REITs generally make excellent dividend stocks.
REIT stocks are sensitive to the economy's interest rates for a couple of reasons.
First, since REITs don't retain earnings, they issue stock and borrow money to fund growth (e.g., property acquisitions). Higher rates make borrowing more expensive (bad for business), while lower rates make debt cheaper (good for business). Second, dividend stocks are less appealing to investors when safer, higher-yield alternatives are available. For example, many income-focused investors might prefer a high-yield savings account to a dividend stock if the yield is comparable because it's safer.
You may have seen headlines about the Federal Reserve cutting the economy's benchmark interest rate. This impacts how banks borrow from each other. The 10-year U.S. Treasury yield (rate) is the benchmark for corporate debt, and that's continued to rise. You can see the inverse relationship between the 10-year rate and Realty Income's share price:
Market forces dictate how Treasuries behave, and the rising yield could be due to several things, such as inflation worries or political factors. The bottom line is that Realty Income's stock may struggle until the 10-year Treasury rate stops rising.
Yes, you can trust the dividend. Here is why.
The critical takeaway today is that external factors only impact Realty Income's business to an extent. Higher rates could drag on Realty Income's growth by making debt more expensive, but it doesn't change the big picture about how good a company Realty Income is.
Realty Income is a world-class dividend stock and is poised to remain so. The company has raised its dividend for 31 consecutive years, a streak that survived the dot-com crash of 2000-2001, the Great Recession of 2008-2009, and the COVID-19 pandemic. Today, the dividend is financially rock-solid.
Analysts estimate Realty Income's 2024 funds from operations (FFO) will be $4.20 per share, translating to a comfortable dividend payout ratio of 75%. In other words, the company's cash profits from running its business would need to plunge over 25% to stress Realty Income's ability to fund its dividend organically.
The company operates a diverse real estate portfolio centered on tenants operating recession-resistant businesses, so the odds are low that rent goes unpaid. Additionally, Realty Income has an A- credit rating from S&P Global, which is a strong credit rating for a REIT. It helps bridge the financial gap during crises like the pandemic in 2020.
Realty Income is a bonafide bargain for 2025
Again, Realty Income's share price woes don't reflect the business. Through nine months of 2024, the company earned FFO per share of $3.14, compared to $2.99 a year ago. Additionally, analysts estimate Realty Income will grow at an average of 6% annually over the long term.
That's what makes the chart below so exciting. The stock trades at just under 13 times its cash from operations (chart substitute for FFO), a massive discount to its average over the past decade. Investors get a dependable 6% dividend yield, with another 6% in estimated growth, offering potential 12% annualized total returns without any changes to the stock's valuation.
O Price to CFO Per Share (TTM) data by YCharts
I consider the current valuation a sufficient margin of safety in case Treasury rates remain higher for longer. If rates eventually decline, the potential valuation increase could generate market-beating total returns for long-term investors. In addition, investors can reinvest Realty Income's dividend to maximize compounding.
Realty Income is a rockstar dividend stock with enough upside at this price to interest all investors, not just high-yield seekers. That makes it a compelling buy to start the new year.
