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2 Iconic Dividend Stocks That You Should Avoid Today

By Reuben Gregg Brewer – Feb 21, 2020 at 11:24AM

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In a yield-starved world, Realty Income and National Retail Properties may look enticing. Here's why you'd be better off avoiding them for now.

Real estate investment trusts Realty Income (O -1.10%) and National Retail Properties (NNN -1.80%) are conservative bellwethers in the net-lease sector. Their yields are solidly above the miserly 1.8% or so you can get from an S&P 500 Index fund today. And they each have long and impressive histories of annual dividend increases.

So let me tell you why buying either one would be a mistake.

Good businesses

There's no denying that Realty Income and National Retail are well-run companies operating in a desirable niche. Companies don't increase their dividend annually for 27 years and 30 years, respectively, by accident. A big piece of this is thanks to what these real estate investment trusts (REITs) do -- which actually isn't that much at the individual property level. 

A compass with the arrow pointing to the word strategy

Image source: Getty Images

The net-lease space in which Realty and National Retail operate is increasingly popular. These REITs essentially buy properties and then rent them back to the sellers with long-term leases. Those leases generally include regular rent hikes and, most important, require the lessees to pay for most of the operating costs of the properties. In the end, it's a lot like a financing transaction, with these REITs largely just sitting back and collecting rent. That's a simplification, but it gives you an idea of why the net-lease model is considered very low-risk.

That said, in order to grow, Realty Income and National Retail raise cash from capital markets via stock and debt sales so they can keep expanding their portfolios. The current low-interest-rate environment is ideal for that, since debt can be issued at low costs. And dividend stocks like these have been bid up to the point where equity capital is pretty cheap, too. Both of these bellwethers have taken advantage of the opportunity to expand their portfolios.

In fact, in many ways, it's a great time to own Realty Income and National Retail Properties -- but that doesn't mean it's a great to buy them.

Priced for perfection

This is an important distinction. If you have owned either of these stocks for a long time, it would probably be a mistake to sell them today. The companies are doing the right things to take advantage of a great opportunity and increasing their long-term values. However, if you are looking to buy today, you are better off putting these REITs on your wishlist and waiting for better prices. To paraphrase value-investing legend Benjamin Graham, the man who helped teach Warren Buffett how to invest, a great company can be a bad investment if you pay too much for it.

The fact that these two REITs are eagerly tapping into the capital markets today should be the first warning sign here. But you don't need to look too hard to see the problem. The stock prices of Realty Income and National Retail Properties are near all-time highs. Since dividend yields move in the opposite direction, it shouldn't be a shock to learn that their yields are near all-time lows. 

NNN Chart

NNN data by YCharts

Sure, the roughly 3.5% and 3.6% yields on offer from Realty Income and National Realty, respectively, are way better than the yield you'd get from an S&P 500 Index fund. But they are still miserly compared to these REITs' own histories. That's great for the REITs, since it reduces their cost of equity capital, but it's not so great for an investor looking to buy the stocks right now. 

Looking at valuation from a different perspective, the price-to-funds-from-operations (FFO) ratio for these two (this is like price to earnings for an industrial concern) is in the 20 range when you look at 2020 FFO guidance. That's a number you would expect to see from a fast-growing tech company, not a pair of REITs designed specifically to generate income for investors that both have long histories of low- to mid-single-digit dividend increases. Although Realty Income and National Retail are both looking to expand today, they are, at their core, slow and steady tortoises. 

Buy at your own risk

There are a lot of things to like about Realty Income and National Retail Properties, but the stock prices aren't among them. With their stocks near record levels and their yields near record lows, most investors are better off putting these industry-leading net-lease REITs on their wish lists. Buying today, when Mr. Market is in love with the shares, is a recipe for lousy long-term returns. Mr. Market will, eventually, sour on these REITs, and happily sell them to you at lower valuations.

Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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Stocks Mentioned

National Retail Properties, Inc. Stock Quote
National Retail Properties, Inc.
NNN
$41.56 (-1.80%) $0.76
Realty Income Corporation Stock Quote
Realty Income Corporation
O
$61.81 (-1.10%) $0.69

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