The MnM Portfolio Supplement - Realty Income Has Separated Itself From The Pack

| About: Realty Income (O)

Summary

Realty Income has outperformed the broader averages in the near term.

The stock is again trading near all-time highs.

I am holding off on acquiring more shares at current prices.

Background

It's been an interesting start to 2016. The S&P 500 has had a rough start, and at the time of writing, has experienced a near double-digit decline. I recently wrote about falling P/E multiples in an article. In that article, I argued that many stocks that I either hold or would like to hold have gotten much more attractive from the perspective of their P/E ratios.

That being said, Realty Income (NYSE:O) is the one stock that I have been patiently waiting for a dip in, in order to fill in my partial portfolio position. You can read more about my portfolio here.

What I find interesting, and somewhat difficult to explain is just why Realty Income has outperformed the broader indexes by as much as it has. We all know that Realty Income is one of the "best of breed" triple net lease REITs out there, and has generally traded at a premium to other REITs, but I don't know that this explains the recent outperformance.

For example, if we look at the last three months, Realty Income is up over 8 percent, while the Vanguard REIT ETF (NYSEARCA:VNQ), which I generally use as an "imperfect" gauge of the REIT industry, is down nearly 5 percent and the S&P 500 is down over 9 percent.

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Source: Yahoo Finance, 27 January 2016

If we blow the charts out a bit and look at performance over the last year, the outperformance to the VNQ is more pronounced than that of the S&P 500, but the margins hold at a similar clip.

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Source: Yahoo Finance, 27 January 2016

Going one step further, if we look at the performance over the past two years, the differentiation becomes much more staggering. The separation has really accelerated in the last quarter, as both the VNQ and S&P 500 have declined while Realty Income has soared.

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Source: Yahoo Finance, 27 January 2016

Analysis

I'm not going to call the current pricing of approximately $55 per share a top, as if we've seen anything lately, it's that Realty Income has momentum behind it. Whether investors see the stock as a safe haven, or if it's being bought up in anticipation of the Federal Reserve relaxing the pace of interest rate hikes (or even cutting them), is anyone's guess. We have received a modest dividend increase, but are still waiting for the latest quarterly earnings to come out, so it's hard to argue that fundamentals are driving the spike in prices.

As Realty Income is a core position in my portfolio, I'm not concerned about trading it, and my interest is merely to find an attractive price to acquire more shares. That being said, at a P/FFO multiple of over 20, it's just gotten too expensive for me to buy any more right now.

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Source: FASTgraphs.net, 27 January 2016

Closing Thoughts

I missed my chance to acquire shares back in August when the flash crash drove Realty Income down sub-$44 per share. Since then, it's been nothing but upside.

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Source: Yahoo Finance, 27 January 2016

I'm still holding out for a $45 per share entry price at which to resume accumulating shares. I have written about this in the past, but I will reiterate my stance that buying at the $45 per share level would leave me acquiring shares at a P/FFO multiple of about 16x-17x. Further, based upon an annual dividend of $2.38 ($0.1985 x 12; rounded), the yield would be approximately 5.3% as compared to the current 4.3% mark.

I wouldn't buy into the current strength, as the multiple is just too high. I would caution as well that the last time we saw prices in the $55 per share range, they didn't hold very long, as evidenced in the following chart.

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Source: Yahoo Finance, 27 January 2016

Where I am looking to accumulate more shares, likely over the coming quarter, is in some of the beaten-down REITs, notably Ventas (NYSE:VTR), which is trading at a P/FFO multiple of just over 12 and Chatham Lodging Trust (NYSE:CLDT) the small-cap hotel REIT that is trading at a P/FFO multiple of just over 8. These feel like bargains to me.

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Source: FASTgraphs.net, 27 January 2016

Click to enlarge

Source: FASTgraphs.net, 27 January 2016

I may be waiting some time for Realty Income to come back down in price. The recent rally has the stock nearly $10 above my desired buy price, and it would take an 18% decline to get back down to my target buy range. While I am willing to pay a premium for Realty Income, I cannot justify buying it right now when there are opportunities to acquire other REITs at much more attractive multiples.

Disclosure: I am/we are long O, VTR, CLDT.

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.