With prevailing interest rates still hovering around mid-single-digit percentages at best, income investors have been forced into stocks in search of yield. There are lots of stocks paying high-yield dividend rates, but the best dividend stocks out there offer income and growth.
That's the beauty of a company like Digital Realty Trust (DLR +0.78%), a real estate investment trust (REIT) that specializes in data centers. Here's why it's worth adding as part of an income-generating portfolio for the long haul.
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A growing business offering a critical service
Real estate has long been a lucrative domain in the investing world. However, the emergence of the digital economy has reshaped the use of real estate. Rather than storefronts and offices, businesses need land that supports their online and digital activity.
That's where Digital Realty Trust comes in. The company owns and operates nearly 300 data centers around the world. It leases these large computing units to over 4,000 different customers operating across all sorts of segments of the economy, from IT firms to financial institutions. Digital Realty offers both data center interconnectivity (in which two or more data centers are linked together from afar to help with the flow of information) and colocation (when an organization rents space for its owned data center computing equipment from a third party).
Given the speed with which the digital world has expanded in recent decades, it's no surprise that this real estate specialist has delivered strong returns. Digital Realty has reported an average 11% per year growth in funds from operations (or FFO, the equivalent of earnings per share for a REIT) per share since 2005 following the company's IPO, leading to an average 10% per year compounded growth in the dividend.
Cloud computing (apps, web services, and the like built using remote data centers) continues to grow at a rapid pace in the wake of the pandemic. Spending on various cloud services and infrastructure could reach $1 trillion a year by the end of this decade, up from a few hundred billion dollars per year currently. Digital Realty thus serves an incredibly in-demand segment of the real estate market.
Paying a steady dividend with room to grow
As with all commercial land, data center real estate development is capital intensive. As is typical in the REIT space, Digital Realty uses debt and new share issuance to pay for expansion. The company has nevertheless been a good allocator of its capital, benefiting from its fast-expanding cloud and data connectivity market. The average interest rate on its debt is a mere 2.2%, far lower than the income yield Digital Realty is getting from renting out its portfolio of real assets.
Based on expected 2021 adjusted FFO, the current dividend eats up just 77% of profits and currently yields 3.3% per year. Full-year 2021 revenue is expected to jump at least 11% over 2020 levels, although adjusted FFO is still expected to be 1% to 2% shy of where it was in 2019 (pre-pandemic). COVID-19 disruption and the company's work to continue expanding via new share and debt issuance as digital needs grow are putting a damper on the bottom line -- for now.
Digital Realty Trust trades for about 22 times adjusted FFO as of this writing. Units of the REIT have been trading sideways for most of this year and could continue to do so, especially if interest rates rise (higher interest rates reduce the value of future profitability). However, for investors looking for income, with the potential for that income to rise along with some gradual share price appreciation over time, Digital Realty Trust is a top name to consider among REITs. It has a history of delivering solid returns and has a clear path to continue increasing that dividend payout over the next decade and beyond.
