If you invested $10,000 in Digital Realty (DLR 0.63%) one year ago, you'd have a little less than $8,300 today -- not a good number. And it compares even less favorably to putting $10,000 into alternative investment options, like the S&P 500 Index, which would be worth roughly $9,300, or the average real estate investment trust (REIT), which would get you $8,800 or so. And yet, now looks like a particularly compelling time to consider buying Digital Realty. Here's why.
In and out of favor
The world is not filled with straight lines but sine curves. That's particularly true on Wall Street, where the pendulum between good and bad performance can be particularly acute and distressing. Over the past year, Digital Realty's stock has clearly been on the downswing, lagging behind the REIT sector as a whole and the broader market. But sometimes bad news can be good news.
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The big story on that front comes from Digital Realty's nearly 4.4% dividend yield. That number is toward the high end of the REIT's historical yield range, suggesting it might actually be cheap today. That said, the yield has been as high as 6%, so deep-value investors might still want to hold off here.
And yet, if you are a conservative investor looking for a reliable dividend stock with a generous yield, Digital Realty should be of interest. Sometimes it is better to jump on an opportunity than risk missing out entirely because you are waiting for the perfect entry point.
The key to the desirability here is the company's string of 18 consecutive annual dividend increases. While the average dividend increase over the past decade was roughly 5%, which is not exactly huge, that's a pretty respectable number for a REIT.
The adjusted funds from operations (FFO) payout ratio has been trending in the high-70% to low-80% range of late, which is reasonable and provides some leeway for adversity. All in all, the company looks like a respectable, though unexciting, dividend growth stock, also noting that it has an investment-grade balance sheet.
Why so glum?
So why are investors down on the stock? For starters, the company's adjusted FFO has been largely treading water for about a year. That's clearly not ideal and highlights that the pricing power in the company's data center niche has been fairly weak. There are two problems on that front.
First, the largest players are, well, huge (think of names like Google), and they tend to negotiate very hard. And those same industry giants are, in many cases, also building their own data centers, making them both customers and competitors. That's a difficult environment, but it's really not new.
The second issue is that the entire data center space is out of favor right now as demand for cloud computing seems to be softening. It's not just one company, either; it's pretty much across the board with the largest industry providers. Wall Street has turned downbeat on this once hot sector, including the companies that provide the cloud backbone, like Digital Realty.
More digital, not less
All in all, the backdrop right now isn't great for Digital Realty or the industry it serves. But long-term investors need to remember that sine curve because good follows bad just as regularly as bad follows good. Without a major global meltdown (or the zombie apocalypse), it is virtually impossible to believe that the world is going to trend in a Luddite direction. So increasing demand for digital everything seems highly likely, and that, in turn, should mean ongoing demand for Digital Realty's offerings, despite the current headwinds.
If you are a long-term income investor, meanwhile, you can collect that fairly generous 4.4% dividend yield while you wait for better days. Not such a bad thing, given that an S&P 500 Index will only net you a 1.55% yield and the average REIT 3.5%.
