The past year has been brutal for investors who own a lot of growth stocks listed on the Nasdaq. The Nasdaq Composite Index currently sits 28% below its 52-week high, putting it squarely in bear market territory. Meanwhile, many of its components have tumbled even further.
Volatility like that can be tough to stomach. While investors can't eliminate volatility from their portfolios (it's the price of admission), they can mute some of its impacts by adding historically lower-volatile stocks to their portfolios. Two stocks that stand out for their ability to produce attractive returns with less volatility are Public Storage (PSA -1.33%) and Realty Income (O 0.24%).
More return for the risk
Public Storage and Realty Income are real estate investment trusts (REITs), which tend to be less volatile than the broader market. Of all the REITs listed in the S&P 500 index, only one has a beta above 1, meaning it's more volatile than the market index. Meanwhile, Public Storage and Realty Income have the lowest betas in the sector at 0.5 or less. What that means is if the S&P 500 moves 1%, these REITs will typically only move about half as much.
However, they've been much less volatile than that over the past year. Both have eked out positive total returns compared to double-digit drawdowns in the S&P 500 and Nasdaq Composite:
Public Storage and Realty Income have historically delivered strong total returns with less volatility than the broader market. Since 1994, they have delivered average total annualized returns above 15% despite being half as volatile as the market. On a unit of risk measure, they're in the 90th percentile of S&P 500 companies for the return they deliver.
What's behind their lower volatility returns?
Several factors enable Realty Income and Public Storage to produce attractive total returns with less volatility than other companies. A major element is the makeup of their portfolios.
Public Storage is a leading self-storage REIT. Self-storage is one of the most resilient property sectors. Demand has steadily grown and tends to remain stable during recessions. Because of that, the net operating income generated by self-storage properties has grown at a 4.8% compound annual rate since 2000, tied with manufactured homes for the highest rate and more than double that of more traditional property types like industrial and multifamily.
Realty Income also benefits from steadily rising rental income. The company focuses on owning freestanding properties net leased (NNN) under long-term agreements to tenants operating in economically resilient industries. Net leases make tenants responsible for building insurance, maintenance, and real estate taxes. Meanwhile, most of its leases feature annual rental rate escalation contracts often linked to the inflation rate. These features enable Realty Income to generate steadily rising rental income from its existing properties.
In addition to their rock-solid portfolios, they have top-tier financial profiles. Realty Income and Public Storage are two of only a handful of REITs with A-rated credit. They also have conservative dividend payout ratios for the REIT sector. Those factors put their dividends on a firm foundation while providing them with the financial flexibility to grow their portfolios of stable income-producing real estate. Those two growth drivers have helped them steadily expand their adjusted funds from operations (AFFO) per share, a key REIT metric of profitability.
For example, Realty Income has grown its AFFO per share at a 5.1% compound annual rate, slightly faster than the average REIT (4%). It has delivered positive earnings growth in 25 out of the last 26 years.
With strong financial profiles, both REITs expect to continue delivering steady growth. Public Storage sees a combination of steady internal NOI growth and expansion-related investments driving 6.7% to 9.2% annual FFO growth over the long term. Add in its nearly 3%-yielding dividend, and the REIT should produce double-digit total annual returns. Meanwhile, Realty Income's combination of a higher dividend yield (it's almost 5%) and the likelihood of a continued 5% compound annual AFFO per share growth rate could also support double-digit total annual returns in the future.
The REITs reduce volatility without sapping returns
Many investors have seen their portfolios fall deeply into the red this year because they own several highly volatile growth stocks. While volatility is usually the price investors need to pay for higher returns, several stocks offer attractive returns with less volatility. That's what Public Storage and Realty Income have delivered over the years. Both appear likely to achieve similar results in the future, making them great options for those seeking to reduce their portfolio's overall volatility without significantly impacting returns.
