Why Isn't Realty Income's Stock Taking Off After Strong Earnings Results?

Realty Income (NYSE:O) continues to deliver the results investors expect from one of the world's largest real estate investment trusts (REITs). Its properties remain nearly fully occupied, its dividend is well covered, and its investment program continues to generate attractive returns.

However, despite another solid earnings report, the stock hasn't generated much excitement. The reason has less to do with the company's real estate portfolio and more to do with how quickly it can grow earnings per share.

Realty Income delivered another solid quarter

Realty Income just keeps getting it done. The REIT grew its adjusted funds from operations (AFFO) by 3.7% in the third quarter to $1.12 per share. That put its dividend payout ratio at a conservative 72.6% of its AFFO, despite continued dividend growth. It has now delivered 5% AFFO per share growth through the first nine months of this year compared to the prior-year period. Its existing real estate portfolio continues to provide steadily rising cash flow. Occupancy was 98.8% at the end of the third quarter, while its rent recapture rate was 103.5% (meaning new leases on the same property were, on average, 3.5% above prior rates).

Meanwhile, the REIT continues to find attractive investment opportunities. It invested another $2.6 billion during the quarter at an initial cash yield of 6.8%. That includes properties acquired in its U.S. Core Fund and through joint ventures, such as its recently established strategic joint venture with KKR in Europe.

The company remains on pace to invest $10 billion this year. That supports its guidance to deliver $4.45-$4.46 per share of AFFO this year, a $0.01-per-share increase from its prior range. That's a more than 4% increase from last year despite headwinds from higher interest rates.

Why isn't that driving the stock higher?

Despite its solid quarterly results, Realty Income's share price isn't soaring. That's likely due to three factors.

Realty Income's growth remains modest. AFFO per share grew just 3.7% despite a 10.3% increase in total revenue. Meanwhile, it only increased its full-year guidance by $0.01 per share at both ends of the range. Due to its large scale and net-lease focus, the REIT isn't growing as quickly as others in the industry.

It also continues to face some headwinds from interest rates. Higher rates increase interest expenses when refinancing existing debt and also drive up borrowing costs for new investments. That's a headwind for AFFO per share growth. Higher rates also weigh on the value of commercial real estate. Realty Income's share price has fallen almost 15% from its peak earlier this year, coinciding with the recent spike in the 10-year Treasury rate.

Given its size, Realty Income requires significant external capital to fund its investment program. Even highly attractive acquisitions can have a modest effect on AFFO per share when accounting for financing costs.

Realty Income isn't going to grow fast, which is why we shouldn't expect its stock to surge, even with a solid earnings report.

A compelling dividend stock, but not necessarily a high-growth investment

The thing with Realty Income is that investors don't need rapid growth to earn an attractive return. At its recent share price of around $57.50, the REIT offers a 5.6% yield at its current monthly dividend rate. It would only need to grow its AFFO per share by around a 4% annual rate to produce an average annualized total return approaching double digits. That assumes no change in its valuation multiple, which is currently a very reasonable 12.9 times.

Meanwhile, there's the potential for additional upside. Falling interest rates and incremental earnings from its expanding private capital platform could drive faster AFFO per share growth in the future. That could also drive some multiple expansion.

Slow and steady can still drive meaningful returns

Realty Income doesn't need explosive earnings growth to deliver solid returns for investors. With a dividend yield around 5.6% and the potential to grow AFFO per share by more than 4% annually, the REIT could generate double-digit annualized total returns. Those returns likely won't come in one big post-earnings move but should arrive steadily as it continues to grow its earnings and pay its monthly dividend.

Matt DiLallo has positions in KKR and Realty Income. The Motley Fool has positions in and recommends KKR and Realty Income. The Motley Fool has a disclosure policy.