How Expensive Is Realty Income?

| About: Realty Income (O)

Summary

Triple net lease giant O has seen a notable price drop.

After a massive run up, that’s kind of nice to see.

But does it make the REIT cheap?

Realty Income (NYSE:O) is one the leading real estate investment trusts, or REITs, in the United States. It is, without a doubt, a well run and well respected company. But being a good company doesn't make its stock a good investment. So, after a swift price decline, is Realty Income cheap enough to buy yet?

Leading the pack

To say that Realty Income had a good run between December of 2015 and July of this year would be an understatement. The shares of this REIT advanced a heady 40% compared to a far more modest gain of nearly 15% for Vanguard REIT Index ETF (NYSEARCA:VNQ), a broad proxy for the REIT space. That run up was driven by investors flocking to the dividend trade, pushing up the value of dividend paying investments in a wild search for yield in a low-yield world.

Since the end of July, however, Realty Income's shares have fallen more than 20%. Vanguard REIT Index ETF, meanwhile, has pulled back "only" 15% or so. That makes sense given the larger run up in Realty Income's price. The big question now, however, is whether or not Realty Income is trading at a reasonable price?

Dividend yield

As a quick valuation tool I often look at a company's historical dividend yield compared to its current yield. It isn't a perfect tool by any stretch, but it's quick, easy, and usually gets the direction of things correct. Realty Income's yield is around 4.4% after the price decline. That's way better than the roughly 3.3% low it reached during the run up, but it still remains toward the low end of the company's historical range.

Now, Realty Income's yield spiked during the 2007 to 2009 recession, hitting around 10%. That would be an incredible deal for this REIT, of course. But it's also not any more realistic than 3.3%. If you look back over the past decade, Realty Income's shares seem to drop until it yields around 5% or so before picking back up again.

For investors looking for a reasonable entry point, a 5% yield seems like a fair target. That, however, would require a price decline to around $48 a share, around 13% below current prices and a full 33% lower than its 52-week high. It's within reach.

That said, a 5% yield wouldn't be a great value, just a fair one, in my mind. A great value would require a yield in the 6% to 7% space. That would require a much larger price drop, of course.

Price to AFFO

Some argue that yield isn't a great valuation tool, and that's completely fair. Which is why it's worth looking at price to adjusted funds from operations, too. Realty Income is projecting AFFO of $2.88 a share. That would put the REIT's price to AFFO at about 19. That's not cheap by any stretch of the imagination and certainly not cheap relative the company's own history.

Since the turn of the century the company price to AFFO has been as low as around 10 and as high as well, what it's been lately. A drop to a 10 price to AFFO is pretty outside the box, but the historical trend suggests something in the 15 area would be more normal. That, in turn, would lead to a price of around $43 a share or a yield of around 5.6%. (That's not far off the number based on looking at the yield, by the way.)

To get down as low as a 13 price to AFFO would hint at a price around $37.50. That would push the yield up to around 6.4%. Anything above that yield or below that price would probably be a good value. Again, that's roughly inline with what the dividend yield alone suggests. That doesn't mean that a crazy market wouldn't push the price lower (and yield higher), but as long as you are comfortable with the entry point that shouldn't be too big an issue with a company like Realty Income.

Still not cheap

Having worked through all of that, though, I can comfortably say that Realty Income is still expensive despite the sizable price decline. As I've noted in other articles, it's cheaper, but not cheap. If you are looking for a good entry point into Realty Income, you still have longer to wait.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.