Investors often view stock performance through a myopic lens, focusing only on stock price appreciation. That’s fine if a company doesn’t pay dividends, but the performance of dividend-paying stocks should really be considered against a broader metric: total return. Real Estate Income (EITHER -4.01%) It helps to show why this is so important and why you might still want to add this boring real estate investment trust (REIT) to your portfolio.
always buying more
Dividends are a powerful tool that offer investors a way to value stocks (relative dividend yield) and a way to capitalize on the returns (dividend reinvestment). It is this last point that is so important to consider if you are a long-term investor. A common tip is dollar cost averaging by regularly investing over time. If you reinvest your dividends, you’re basically doing just that. You just don’t have to put up the cash; the company you have invested in does this for you. The impact can be huge.
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REIT Realty Income, for example, has turned a $10,000 investment in the early 2000s into $228,000 today. That includes the reinvestment of dividends. Take out reinvested dividends and price appreciation alone has increased that $10,000 by “only” $61,000 or so. That is a big difference! Putting those numbers into percentages: The stock price is up a little over 500%. With the reinvestment of dividends, the value of Realty Income has grown north of 2100%.
This is where it gets really interesting. In the same period, the S&P 500 Index has turned $10,000 into around $25,000 with no dividend reinvestment. With the reinvestment of dividends, that figure grows to $38,000. In percentage terms, that translates to 150% growth without reinvesting the dividend and 280% growth with the dividend reinvested. Those numbers are not as good as the ones Realty Income presented.
One of the biggest differences between the S&P 500 Index and Realty Income is that Realty Income has always had a higher dividend yield (materially higher at some points). That means more money is reinvested to buy new shares, increasing returns over time.
dividend yield data by YGraphics.
Dividends by design
To be fair here, REITs were created to pass on the income derived from ownership to investors. Realty Income, specifically, owns single-tenant commercial and industrial properties that generate reliable cash flows. To avoid taxes at the corporate level, REITs pass on at least 90% of profits, often more, to shareholders as dividends. Thus, income is the big draw for REITs, which is not so true for the S&P 500 index, an industry-spanning list of companies that contains both dividend payers and non-dividend payers. Today, for example, Realty Income’s 4.8% dividend yield is much more than double that of the S&P 500 Index. Which is actually one of the reasons it might still make sense for long-term investors to term buy this dividend compounding machine, assuming you reinvest those payments.
But that is not the only reason. Approximately $38 billion market cap Realty Income is one of the largest players in the net leasing niche. Net leasing means that the lessee is responsible for most of the costs at the level of ownership of an asset. With a large enough portfolio, this is a very low-risk way to invest in property. Realty Income owns more than 11,000 buildings. It also has a fairly diversified portfolio, with around 80% of the income coming from commercial real estate and the rest from industrial and “other” assets. About 10% of the total rent comes from Europe. More diversified options exist, but the Realty Income breakdown is quite desirable.
Then there is the dividend, which has increased annually for 27 years in a row. That makes Realty Income a dividend aristocrat. On top of that, the dividend is paid monthly, which increases the number of times you reinvest the dividend.
And Realty Income’s strong business has earned it investment-grade credit ratings and an industry-leading valuation. These factors mean it has a low cost of capital, which helps support growth driven by acquisitions. Add that to the size of the REIT and you can make deals that your peers couldn’t handle. This should help ensure that Realty Income continues to perform at its best over the long term. In other words, there’s no reason to think this dividend reinvestment machine will slow down anytime soon.
a good starting point
To be fair, Realty Income began the previous comparison period with a double-digit dividend yield. That gave him a huge advantage when it came to reinvesting dividends. However, given the still substantial difference between the performance of the S&P 500 and Realty Income, and the many advantages the REIT has today over its smaller peers, it remains an attractive name for long-term investors. That includes both income-focused and non-dividend-focused investors alike.
