Bet on the wrong management team, however, and your cash machine can become a money pit. To determine the better dividend stock, I'll dig into which management consistently follows through on its mission, intelligently allocates capital, and promotes and nurtures competitive advantage.
ARCP: "[T]o generate monthly dividends from a durable and predictable level of monthly rents paid by primarily investment grade and other credit-worthy tenants,and to provide significant growth potential."
Despite only going public in September 2011, ARCP is the largest net-lease REIT, has the highest percentage of investment grade tenants -- normally meaning of stronger credit quality -- and has the lowest percentage of rent concentrated in its top 10 tenants. Put it all together, and it creates a durable and predictable monthly dividend.
The company has also shown its growth potential, increasing total properties threefold, from 1,329 at the end of 2013 to 4,429 today.
Realty Income: "Since our founding in 1969, our mission has been to provide our shareholders with dependable monthly dividends that increase over time."
For Realty Income, the proof is in the pudding. The company has paid a dividend every month for 44 years and has increased its dividend 77 times since 1994 -- which works out to a dividend increase every quarter for 20 years.
The company has been successful simply because of its focus on buying great properties, leasing them to good businesses, and holding those properties for the long term.
Smart capital allocation
Because REITs pay out 90% of their earnings in dividends, raising capital and allocating it appropriately is essential to growing over time. By looking at each companies' return on equity, investors can get an idea of how well each company is turning equity into adjusted funds from operations, or AFFO, a more useful profitability metric for REITs.
The illustrated time period is short, but it does a good job of demonstrating the stability and consistently of Realty Income, as well as ARCP's transition into the largest net-lease REIT. In 2014 alone, ARCP grew total assets by $13.5 billion -- Realty Income did $887 million in the same time -- however, since returns haven't caught up to the massive increase in total equity, the company's ROE has fallen dramatically.
ARCP is a great example of why growth may not always be beneficial for shareholders. To pay off some of the debt created to fund these acquisitions, ARCP -- after explicitly telling investors that its stock price was undervalued -- issued 138 million new shares of stock this past May.
Then on June 3, the company received a scathing letter from Marcato Capital Management -- which at the time owned 21.8 million shares -- stating that it was "disturbing" that the company would dilute shareholder value by selling shares at a discount to their true value. The rapid growth was making the company confusing to evaluate, and the stock price was being unfairly beaten down, Marcato charged.
If ARCP's investments pay off, ROE will probably improve over time. However, it remains a question whether such rapid expansion was truly in shareholders' best interest.
If nothing else, acquisition growth has helped ARCP create a competitive advantage.
As the largest players in the space, ARCP and Realty Income are more diverse and therefore less susceptible to late payments, non-payments, regional economic woes, or tenants that don't renew their leases. Also, because these are large, stable companies that receive rent from strong, creditworthy businesses, they can borrow at lower costs than their competitors.
However, as ARCP's rapid growth has proved, size isn't a durable competitive advantage in the REIT space. For both companies, their true competitive advantage lies in their management's abilities. That's one of the major reasons I like Realty Income's track record over ARCP.
The better dividend stock
In most cases, it's east to say that Company A is better than Company B. In this case, however, I believe both companies are good investments, given the right investor.
If you're looking for a higher-yielding stock -- 8% for ARCP versus 5.3% for Realty Income -- with big upside, and you're willing to overlook the company's limited track record, ARCP may be the stock for you. With that said, for my money, I like Realty Income's more stable and consistent approach that has proved successful for decades. So while I believe both business have their advantages, I believe Realty Income is the better dividend stock and a strong long-term investment.
Dave Koppenheffer and The Motley Fool have no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.