Adding Realty Income As Another Pillar To My Portfolio

| About: Realty Income (O)

On Wednesday, July 10th, I added Realty Income (NYSE:O) as another pillar in my portfolio at a price of $43.16. I previously wrote an article titled "4 Dividend Growth Stocks That Are The Pillars Of My Portfolio." In that article, I discussed the four stocks I own and the attributes they have that make them the pillars of my portfolio. These attributes are sustainable product, wide moat, rising dividend and a reasonable entry price. In June of 2012, I added Walgreen (WAG) as a fifth pillar and have now added Realty Income. The pillars of my portfolio are companies I never intend to sell unless the business conditions deteriorate.

Now normally when I write about a stock I bought, I try to provide a fundamental analysis of what I believe the merits of the company are. However, Realty Income is a Real Estate Investment Trust (REIT), and Seeking Alpha has some excellent REIT experts that write about these assets better than I can. One of those writers, Brad Thomas, has written some excellent articles on Realty Income, including this recent one, which I suggest people read.

So instead of providing a deep analysis of O, what I thought I would do is provide a summary of how Realty Income's business has the attributes I look for and how it fits into my portfolio.

Description - Realty Income is a 44-year old publicly traded real estate company that likes to refer to itself as the "monthly mortgage company." It has a yield of about 5% and pays its dividend monthly. With the recent acquisition of American Realty Capital Trust, Realty Income has over 3,500 properties located in 49 states. The majority of tenants are retail, but O has been trying to diversify and retail now makes up less than 80% of its revenue.

Valuation - When stocks began trading for the year on January 2nd, Realty Income opened at $40.85, but quickly rose to the $55.00 range in mid-May -- a 37% gain in five months. At that price, several articles were written on Seeking Alpha debating whether O had entered "bubble" territory. The talk of a bubble ended when the Federal Reserve began discussing tapering their bond buying and interest rates spiked. Realty Income, along with other REITs, quickly fell in price, with O reaching a low of $39.83 on June 24th.

Determining valuation for REITs is a little more difficult than it is for your average large corporation. Standard metrics like price to earnings and price to earnings growth are not commonly used. Instead, many analysts use "Funds From Operations," which is simply the cash flow from operations. Realty Income pays out about 89% of its fund from operations to shareholders.

So is O cheap? No I don't think so, but I also don't think it is overpriced. Realty Income's mission is to pay monthly dividends. On its website, it promotes the long-term effect of compounding the dividends paid. In my opinion, the reason to own O is for the dividend. If you are looking for a big capital gain, I would suggest you look elsewhere.

Sustainable Product - Realty Income owns over 3,500 properties under long-term leases with various tenants from various industries in various locations. As long as Realty Income can continue to acquire new properties, it will be able to continue raising its dividend. Real estate is never going to go away and the REIT world is full of players, both big and small. In addition, there are always developers building new properties for lease. Through the purchase of individual properties, or through the purchase of other REIT companies, O should be able to expand for a long time.

Wide Moat - Is Realty Income the only REIT in the country with no competition? No, it sure isn't. There are many REITs. However, there are very few that pay monthly dividends and only one that has done it as long O. In addition, Realty Income's size gives it an advantage over some other REITs, as it is able to use its bigger checkbook to scoop up the better properties.

Despite the fact O does not have a wide moat like a Coca-Cola (NYSE:KO), it does have some advantages over other REITs, enough so that I am willing to give this category a pass.

Dividend - From Realty Income's website, we see that O currently yields 5%, with a monthly dividend of $0.18 a share. Realty Income has grown the dividend 142.1% since 1994, has paid 515 consecutive dividends, and has had 63 consecutive quarterly increases. It should also be noted that O did increase its dividend during the 2008/2009 financial crisis.

Realty Income easily meets my dividend criteria and I also like that O pays the dividend monthly. Over a long period of time, and I intend to hold O for the long term, the monthly dividend will increase the compounding effect.

Why I Added Office Realty

To understand why I bought O, I think a quick review of the current pillars of my portfolio would be helpful.

Exxon Mobil (NYSE:XOM) - Large integrated oil company and a direct descendent of John D. Rockefeller's Standard Oil. XOM is one of the world's largest producers of oil and gas and also has a large chemical business.

I bought the current shares of XOM in October 2008 and have periodically added to those original shares. My current cost basis is $66.64; including dividends paid, I have a gain of 50.99%. XOM yields 2.7% and my yield on cost is 3.78%

I own XOM because I believe oil and gas will be with us for very long time and XOM with its large global footprint and second-to-none balance sheet has an advantage over many of its competitors.

McDonald's (NYSE:MCD) - One of the world's largest restaurant chains serving fast food every day to 68 million people in over 119 countries and 33,000 locations.

I first bought shares in MCD in January 2008 and have periodically added to those original shares. My current cost basis is $65.20: including dividends paid, I have a gain of 79.74%. MCD yields 3.10% and my yield on cost is 4.96%.

I own MCD because I believe it is the best-run restaurant chain in the world and has years of expansion ahead of it as MCD enters new countries and large numbers of the world's population enter the middle class.

Coca-Cola - Coca-Cola, as everyone knows, is the world's largest beverage company, but I think it is more. I believe Coca-Cola is one of the great companies of all time. From its beginning in 1886, it has grown to a company that operates in over 200 countries and provides 1.7 billion beverage servings a day.

I bought KO in February 2010 and periodically added to those original shares. My current cost basis is $28.63 (split adjusted); including dividends paid, I have a gain of 53.51%. KO yields 2.7% and my yield on cost is 3.91%

I own KO because I believe it has the widest moat of any publicly traded company. No matter where you go in the world, if you want to buy a beverage, you are most likely going to have multiple Coke products to choose from. KO has a goal of increasing sales of its beverages from 1.7 billion a day to 3 billion a day by 2020.

Kinder Morgan (NYSE:KMI) - Kinder Morgan is the general partner and owns the incentive rights to Kinder Morgan Energy Partners (NYSE:KMP) and El Paso Pipeline Partners (NYSE:EPB). KMI owns an interest in or operates approximately 75,000 miles of pipelines and 180 terminals. The pipelines transport natural gas, refined petroleum products, crude oil, carbon dioxide (CO2) and more. KMI also stores or handles a variety of products and materials at terminals such as gasoline, jet fuel, ethanol, coal, petroleum coke and steel.

I bought KMI in several lots in January 2012 and have not added since. My current cost basis is $33.75; including dividends paid, I have a gain of 21.60%. KMI yields 3.8% and my yield on cost is 4.5%.

I own KMI because the United States is undergoing an energy renaissance and the infrastructure to carry the energy will be vital. With its unparalleled assets, KMI will benefit from the increase in energy production. In addition, KMI has indicated it intends to raise its dividend 12.5% a year through 2015 and 10% a year long term.

Walgreen - Walgreen in the largest drug store in the United States with over 8,000 stores. Walgreen is also the 45% owner of Alliance Boots, a large European pharmacy-led health and wellness group. In addition, Walgreen recently entered into an agreement with AmerisourceBergen (NYSE:ABC) that will allow WAG to eventually take up to a 23% stake in ABC

I bought WAG on June 22, 2013 for $29.80, and I have not added to that position. Including dividends paid, I have a gain of 67.11%. WAG currently yields 2.4% and has recently announced a dividend hike of 14.5% payable September 12th. The increased dividend will raise the yield to approximately 2.6%

I own WAG because I believe management is intent on changing the drug store into a worldwide pharmacy-led health and wellness store. I believe this change will turn WAG into the international leader in health and wellness. I also believe the demographics of an aging population and increased heath care under the Affordable Care Act will benefit WAG.

Portfolio Self-Appraisal

Reviewing my portfolio over the last few months, I came to the conclusion that I needed a high yielder. Although all the stocks I own pay a nice dividend and all the dividends have steadily been raised, the overall yield of the portfolio was less than I wanted. Several weeks ago, I bought Procter & Gamble (NYSE:PG) -- nice 3% yield -- but felt that P&G was too similar to other, so-called, defensive stocks I own. I also read a Seeking Alpha article by Chuck Carnevale that mentioned P&G was overvalued, so I sold P&G two weeks after I bought it for a 2% gain.

After selling P&G, I went back to researching stocks, looking for a high yielder that I could add to my portfolio. MLPs were out because I already own KMI and I don't want to deal with the tax hassle that comes with MLPs. I then focused on utilities and REITs, both of which I have considered overvalued for some time. I took a long look at Wisconsin Energy (NYSE:WEC), which has a 3.2% dividend, which for utilities is small. However, WEC has stated it intends to increase its payout ratio and increase the dividend double digits for the next couple of years. Ultimately, I took a pass on WEC because I felt the dividend would be too small, even with the aggressive increases. I have had my eye on Realty Income for years, but either found another stock more enticing, or felt O was too expensive. That changed several weeks ago when interest rates spiked and Realty Income's stock price dropped to the low 40s. I researched the stock and found its website quite informative concerning the compounding effect of dividends over time. I knew that was the case, but actually seeing some real numbers compounded over time was very illuminating. It was at that point I decided to buy Realty Income. I determined O was at a fair price and made the move to buy Realty Income last Wednesday right before the close.

My Plan for Realty Income

Let me be clear, I own O for the dividend. I will be watching Realty Income's business like I watch the businesses of all the stocks I own, but my focus will be on its ability to continue to raise the dividend. As long as the dividend is paid and raised I will be happy, regardless of the stock price movement. I say that because I fully expect the stock price to be volatile. If interest rates rise, it is possible the price of Realty Income will fall, which is fine because I will buy more and lower my cost basis. It is my goal to eventually own enough shares that with each monthly dividend I reinvest, I buy another share. At that point, I'll set O on auto-pilot and let the miracle of compounding work. At today's price, that means I will need to own approximately 250 shares. It will take a few more purchases to get to 250, but I will get there.

Disclosure: I am long O, MCD, KO, XOM, WAG, KMI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.