Is Realty Income the Right Stock to Retire With?

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Now more than ever, a comfortable retirement depends on secure, stable investments. Unfortunately, the right stocks for retirement won't just fall into your lap. In this series, I look at 10 measures to show what makes a great retirement-oriented stock.

Real estate investment trusts have made a big splash among investors looking for big dividends. But while much of the attention on REITs has focused on those investing in mortgage-backed securities, others, including commercial real estate REIT Realty Income (NYS: O) , have more modest yields and more exposure to the commercial real estate market. Is Realty Income a good bet on a future real estate recovery or a lightning rod for the next downturn? Below, we'll look at how the company does on our 10-point scale.

The right stocks for retirees
With decades to go before you need to tap your investments, you can take greater risks, weighing the chance of big losses against the potential for mind-blowing returns. But as retirement approaches, you no longer have the luxury of waiting out a downturn.

Sure, you still want good returns, but you also need to manage your risk and protect yourself against bear markets, which can maul your finances at the worst possible time. The right stocks combine both of these elements in a single investment.

When scrutinizing a stock, retirees should look for:

  • Size.Most retirees would rather not take a flyer on unproven businesses. Bigger companies may lack their smaller counterparts' growth potential, but they do offer greater security.
  • Consistency.While many investors look for fast-growing companies, conservative investors want to see steady, consistent gains in revenue, free cash flow, and other key metrics. Slow growth won't make headlines, but it will help prevent the kind of ugly surprises that suddenly torpedo a stock's share price.
  • Stock stability.Conservative retirement investors prefer investments that move less dramatically than typical stocks, and they particularly want to avoid big losses. These investments will give up some gains during bull markets, but they won't fall as far or as fast during bear markets. Beta measures volatility, but we also want a track record of solid performance as well.
  • Valuation.No one can afford to pay too much for a stock, even if its prospects are good. Using normalized earnings multiples helps smooth out one-time effects, giving you a longer-term context.
  • Dividends.Most of all, retirees look for stocks that can provide income through dividends. Retirees want healthy payouts now and consistent dividend growth over time -- as long as it doesn't jeopardize the company's financial health.

With those factors in mind, let's take a closer look at Realty Income.

SizeMarket cap > $10 billion$4.41 billionFail
ConsistencyRevenue growth > 0% in at least four of five past years5 yearsPass
 Free cash flow growth > 0% in at least four of past five years4 yearsPass
Stock stabilityBeta < 0.90.79Pass
 Worst loss in past five years no greater than 20%(8.2%)Pass
ValuationNormalized P/E < 1843.47Fail
DividendsCurrent yield > 2%5.3%Pass
 5-year dividend growth > 10%4.1%Fail
 Streak of dividend increases >= 10 years17 yearsPass
 Payout ratio < 75%151.6%Fail
    
 Total score 6 out of 10

Source: S&P Capital IQ. Total score = number of passes.

With six points, Realty Income gives conservative investors some but not all of what they'd like to see in a stock. While the dividend is right, the REIT faces challenges that raise concerns.

Realty Income owns 2,600 properties in 49 states, with an emphasis on diversification. Its properties span 38 industries and include 134 tenant companies, and it typically gets long-term leases for 15- to 20-year timespans.

Realty Income's claim to fame is its unusual dividend policy. Most big REITs, including HCP (NYS: HCP) , Equity Residential (NYS: EQR) , and Simon Property Group (NYS: SPG) , only make dividend payments every quarter, like the vast majority of U.S. stocks. But Realty Income bills itself as "The Monthly Dividend Company," with a specific focus toward retiree investors who need income on a monthly basis. And with a 17-year record of raising those dividends every year, Realty Income has made shareholders happy for a long time.

What may be most surprising is how well the REIT held up during the market meltdown. Losing only 8% in 2008, Realty Income clearly didn't suffer from the same cash-flow challenges that ended up leading General Growth Properties (NYS: GGP) to seek bankruptcy protection, eventually emerging to spin off Howard Hughes Corp. (NYS: HHC) and make millions for its investors.

For retirees and other conservative investors, Realty Income's biggest problem is its rich valuation. But viewed on a cash-flow basis, the REIT's dividends appear much more sustainable. For those seeking solid, dependable monthly income, Realty Income has been a strong choice for decades and should continue to do so well into the future.

Keep searching
Finding exactly the right stock to retire with is a tough task, but it's not impossible. Searching for the best candidates will help improve your investing skills, and teach you how to separate the right stocks from the risky ones.

Add Realty Income to My Watchlist, which will aggregate our Foolish analysis on it and all your other stocks.

If you want to retire rich, you need to be confident that you've got the basics of your investment strategy down pat. See if you're on track by following the "13 Steps to Investing Foolishly."

At the time this article was published Fool contributor Dan Caplinger doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of Howard Hughes Corp. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool has a disclosure policy.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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