Realty Income Rallies Post-Earnings Miss-Here's What Drove It

Even after a decline in net earnings per share (EPS), shares of Realty Income Corp. (NYSE: O) are rallying by roughly a point and a half in the pre-market hours the day after they released their quarterly financials. This can be confusing for investors, as some companies perform well on good earnings or rally on bad earnings.

The reason is that it isn’t always EPS that matters the most, especially for a company in the real estate sector like Realty Income.

Being a real estate investment trust (REIT), this stock and its financials are often treated differently than other names in the stock market, and for good reason. In this sense, investors don’t frequently care about how much the company makes in EPS but how much the property portfolio generates in appreciation and rental income.

More than that, there is one specific benefit investors can get from buying into a REIT like this one, and that is a steady stream of income, since these vehicles are required (by law) to pay out a fixed percentage of their rental income to shareholders in the form of dividends.

That being said, Realty Income offers shareholders both upside potential and income benefits.

The Bullish Side of Earnings

Although Realty Income's net EPS figure declined from 30 cents in the same quarter a year ago to 22 cents this quarter, the stock rallied because the market recognizes that this decline doesn’t necessarily signal bad news moving forward, especially for this REIT.

First, the decline in operating income came directly from higher expenses, not a loss in rental income, which grew above inflation at a hefty 5.2% over the year. The rise in expenses was primarily attributed to interest charges paid. This company-specific issue is also industry-wide, as all REITs now pay higher rates.

Other charges, such as property depreciation, also increased significantly over the year. This is good news for investors as it means a potential tax benefit by the end of 2025 and indirectly points to Realty Income expanding its property holdings.

With this in mind, here is what really matters to REIT investors, after they broke down the expenses and rental income growth, pointing to a much better future than the markets are priced in today. Dividends per share increased to 80.5 cents this quarter, up 3.8% compared to last year’s 77.6 cents.

No company in its right mind would increase its dividend payouts if the underlying fundamentals weren’t that strong, or even as bad as the price action seems to suggest for Realty Income, meaning investors can continue with a more confident and bullish view of the company moving forward.

Institutions Like What Management Did

More than just increasing the dividend payouts, Realty Income management made a move to keep these increases coming, as well as turning the lower EPS figure upside down for the coming quarters. By investing up to $1.2 billion at an average cap rate (yield) of 7.2%, Realty Income is directly expanding on its future earning power.

This brings more good news for investors relying on this REIT for income. It also prompts Wall Street analysts to reconsider their consensus rating of Hold and valuation target of $61.4 per share on Realty Income stock, indicating only 7.8% upside from its current price.

A more effective approach to valuations is to consider that the company is acquiring properties at a 7.2% yield, which is on the higher end of the real estate spectrum, and also means the REIT’s own portfolio may be undervalued today. A ramp-up in property valuations will have a direct impact on the stock’s book value and therefore its valuation per share.

With this in mind, it should come as no surprise to investors to notice that the entire market is now willing to pay up to 51.8x in a price-to-earnings (P/E) ratio for Realty Income stock, commanding a massive premium over the REIT industry’s average valuation of only 31.1x today.

As dividends have increased, they now offer shareholders an annualized yield of 5.7%. The discount in the company’s property holdings becomes apparent, allowing investors to justify the market’s willingness to overpay for this REIT, given its expectation for some upside potential in the coming quarters, not to mention the ability to lock in a very attractive yield.

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The article "Realty Income Rallies Post-Earnings Miss—Here’s What Drove It" first appeared on MarketBeat.