If You Are Here Seeking Alpha, Why Are You Buying Realty Income Or Other High-Yield Equities?

Summary
• Seeking Alpha is about total returns, not just high dividends; Realty Income has not delivered alpha over the last 3, 5, and 10 years.
• High dividend yields like AT&T’s 5.29% and AGNC Investment’s 14.1% often erode principal, resulting in poor total returns.
• AT&T and AGNC Investment have underperformed the S&P 500 significantly, with AT&T earning a C- and AGNC a negative return over three years.
• Realty Income, despite its reputation, has a D+ performance grade and F+ valuation, making it unsuitable for those truly seeking alpha.

I have now been a Seeking Alpha analyst for the last thirteen years. I was recruited by the late Eli Hoffman after he read several of my articles on MarketWatch and TheStreet.com. I was recruited to write for TheStreet.com by Jim Cramer.

I was intrigued with the concept of “Seeking Alpha” as that has been my main driving force ever since I became a professional manager almost 25 years ago. Alpha is the outperformance of your holdings vs. the S&P 500. That is what I am all about every day in the market.

I guess that it is the thrill of the chase and the excitement of finding new disruptive stocks or just stocks that have superior management and that have consistently delivered alpha over the years.

I remember the wholesaler for Realty Income (NYSE:O) coming around to the brokerage firm that I began working for back in the late nineties. This firm was located in the North County of San Diego, not too far from Realty Income’s headquarters in Escondido, California. They had a unique concept of paying monthly income to their investors.
I remember the wholesaler leaving us advisors with some wall clocks that were labeled “monthly income.” I cannot argue that the company has not lived up to their promise of monthly income since then, nor can I argue that they have not been one of the best REITs in the market over the years.

They have very good management that has managed risk well, grown at a sustainable pace, and steadily increased their dividend over the years. But, if you are here seeking alpha, they have not delivered any over the last 3, 5, and 10 years.

I remember visiting a retiree over twenty years ago at the behest of his wife. Her husband had invested in high-dividend paying stocks and his portfolio had gone from around $1 million dollars to just over $300k. The man had lost almost $700k in principals over the course of several years.

When I questioned him about it, his response to me was, “what do I care about my principal, I am still receiving my dividends! There was nothing I could do to talk sense to this man. I tried to teach him the true concept of total return, but there was no way that I was going to get through to him.

When I left his home, I told his wife that I was sorry, but there was nothing that I could do.

I know that on the surface those high-dividend yields of 5%, 8%, 10%, or even more seem very attractive, but one has to be honest and look at the TOTAL RETURNS of your portfolio over the years. Alpha is not earned by the value of the dividends that you receive, but by the TOTAL value that your portfolio grows by over the years vs. the S&P 500.

Heck, even a Ponzi scheme can pay you a 10% dividend over the years, but your principal is dwindling each year.

To show you what I mean by this, let’s look at the very popular so-called DJIA stock AT&T. The stock currently sports a fat dividend yield of 5.29%. This is obviously at the lower-end of the high-yielding spectrum, but it illustrates the point of the concept of total return. We will return to the analysis of Realty Income after we go over two examples of dividend-paying stocks.

AT&T has delivered an average total return of just 3.72% over the last ten years. The dividend yield that investors have been receiving has been eroded away in part by capital depreciation or loss of principal. Overall, it earns a performance grade of just C-.

During that same period of time, the S&P 500 has delivered an average return of 17% per year. Over the last five years, the stock has delivered a total avg. annual total return of just 1.46% while the S&P 500 has delivered an average of 16.4%.

The only saving grace for AT&T is that is up 54.8% over the last twelve months due to a falling interest rate environment, a move to safety in the market, and the anticipation of rate cuts upcoming by the FED. If you took out those last twelve months, the 3,5, and 10-year returns would be a lot worse.

That is a long time to wait for those returns to finally go positive after being in negative territory for the last several years. That is a lot of risk to take for very meager returns.

Furthermore, investing is all about the anticipation of future returns. That is where valuations come in. My current 5-year valuation for AT&T calculates very poor prospects going forward.

I calculate just 45.12% upside potential for T over the next five years. I require 80% or more in the stocks that I consider. AT&T currently earns a value grade of “F.”
No thanks!

Now, before we return to Realty Income, let’s look at another high-yield equity. This popular, high-yield stock currently sports a dividend yield of 14.1%! How can one pass up an investment in AGNC Investment at just $10.21 per share?

After all, I doubt that the S&P 500 will do 14.1% per year over the next five years. This seems to be an almost a sure way of earning alpha during that period of time.
Not so fast, remember that total return is the sum of your gain or loss of principal and the dividends that you receive. While the dividend yield may be the number that appeals to your greed or gets page reads for your article, it is the total return that tells the honest truth:

As you can see from the numbers above, AGNC Investment (AGNC) has done very poorly over the years on the capital gain side of the equation. In fact, much of the dividend that you have received has been eroded away by capital depreciation!

That has yielded a meager net average total return of just 3.83% per year over the last ten years. Investors have taken a very large risk for very paltry returns. Mark Twain is famous for saying: “I don’t care about the returns on my investment, but the return of my investment!” (paraphrased)

Over the last five years, returns have averaged a total of just 4.51% per year despite a double digit dividend yield that mostly evaporated in thin air somewhere. Over the last three years, investors have lost all of their yield and then some! Their net annual return has been -1.7% per year! Ouch!

Okay, the last twelve months have been good with a total return of 22.1%, but keep in mind that the returns would be even worse over the last decade were it not for that.
I think I will pass on that big dividend yield that’s trying to lure me in.

Now, let’s conclude by looking at one of the most highly regarded dividend-yielding stocks over recent years. This stock probably gets written about more than any other stock on this site. Now it is my turn to look at the actual TOTAL return of the stock over the years.

When I compare the stock against the other 4,845 stocks, ETFs, and Mutual Funds in my Best Stocks Now Database, Realty Income (O) earns a relative performance grade of D+. That is not very good.

While it has had a respectable average total return number of 8.39% over the last ten years (this is against 17.0% for the S&P500), its total returns over the last three and five years have been very meager. It has had an average total return of just 1.68% over the last five years, and 1.14% over the last three years. How much has inflation been during those same time periods? The stock has almost kept up with the S&P 500 over the last twelve months, but then again it has been a good environment for interest rate-sensitive stocks, and also keep in mind that the last twelve months have helped O’s longer-term returns, but the stock still earns a relative performance grade of just D+.
Maybe the current valuation of the shares offers extremely good upside potential going forward? Let’s have a look.

The stock currently earns a valuation grade of F+ with 52.93% upside potential over the next five years. Keep in mind that this valuation includes the current annual dividend yield of 5.06%.

If you have come here truly seeking alpha, you are barking up the wrong tree with Realty Income. Could you do worse than Realty Income? Certainly. Could you do a whole lot better than Realty Income? I only have 20 spots open in each of my portfolios. This does not leave any room for mediocre equities like Realty Income or AGNC.