Cheap stocks are often cheap for a reason. And determining a stock’s relative value is not a simple matter of evaluating its price-to-earnings ratio or checking on its dividend yield. Sure, these can be indicators, but they can also be deceptive.
One of the biggest mistakes novice investors make is choosing a laggard and ignoring a leader simply because the laggard has a lower P/E ratio or a higher dividend yield. A low P/E might be a signal that investors think future earnings will be a lot lower, while an outsized dividend yield could be too good to be true.
When looking for cheap stocks, it makes sense to pick up quality companies that are trading at a discount to their historical valuations. Here are three real estate investment trust (REIT) stocks that are in the bargain aisle but are still top-quality companies.
1. Simon Property Group has a fat dividend yield
Simon Property Group (SPG -3.74%) is one of the best-run mall REITs in the United States. The stock has been under pressure this year because the Federal Reserve has been raising the Fed funds rate, which has ripple effects that could lead to negative effects for consumers. And yet, despite the volatile economic environment and high gasoline prices, Simon Property Group reported that its retail tenants achieved record sales per square foot in the second quarter of 2022, an increase of 26% compared to the same period last year.
Simon Property Group is guiding for 2022 funds from operations (FFO) to come in between $11.70 and $11.77 per share. Funds from operations are the typical way REITs report income. This is because depreciation is a major charge to earnings under generally accepted accounting principles (GAAP), but it is a non-cash charge. This means that GAAP earnings understate the cash flows of the REIT. At the midpoint, this gives the company’s stock price a multiple of 8.5 times this year’s FFO per share. For a REIT, that’s a reasonable price.
The stock’s dividend yield is 7%, and its $7 per share annual dividend is more than amply covered by its FFO-per-share guidance. this is a stock for which a high dividend yield is not a red flag. Simon Property Group will face headwinds as long as the Fed is raising rates and the stock price could be discounted short-term. However, long-term investors should take advantage of the negative sentiment to get in while the well-supported dividend yield is elevated.
2. American Tower benefits from increased mobile data usage
American Tower (AMT -3.73%) is a cellphone tower REIT that is benefiting from the increased use of mobile data. A recent report from Eriksson Mobile estimates the use of mobile data will grow by a factor of 4.2 between 2021 and 2027. This will be driven by more data-intensive apps on smartphones as well as increased adoption of 5G networking technology.
The cellphone tower business has some pretty big barriers to entry related to licensing, regulations, and difficulty finding suitable locations. Three companies — American Tower with nearly 43,000 towers, Crown Castle (CCI -3.93%) with around 40,500 towers, and SBA Communications (SBAC -2.91%) with 17,400 towers — dominate the business in the U.S.
American Tower stock has outperformed the market this year and yet the P/E ratio for the REIT has fallen thanks to its strong performance. Earnings continue to rise and have a long runway to increase as 5G networks roll out to more locations around the country.
The company has another interesting feature: It has raised its dividend every single quarter over the past decade. That suggests the company is generating so much free cash flow, it can’t find enough ways (such as expansion) to spend it. It has a dividend yield of 2.23%, which sounds somewhat low for a REIT, but that yield is actually on the high side of its long-term yield range.
3. Realty Income is trading at a big discount to the purchase price of a competitor
Realty Income (O -3.89%) is a REIT that focuses on single-tenant properties using an unusual rental structure called a triple-net lease. Under this arrangement, the tenant is responsible for not only the rent but also the taxes, maintenance, and insurance. For the tenant, the lease arrangement doesn’t cost much more in rent than a mortgage payment would cost. But triple-net lease arrangement gives the tenant company more flexibility in how it distributes the expenses in its accounting, freeing up some capital to spend elsewhere.
Realty Income has been around since 1969 and has seen a variety of economic cycles. It is a Dividend Aristocrat, which is an S&P 500 company that has raised its dividend annually for at least 25 consecutive years. Realty Income performed well during the pandemic and consistently hiked its monthly dividend when many REITs were forced to cut theirs. At its current stock price, the dividend yield is 4.6%. The company has guided for 2022 FFO per share to come in between $3.92 and $4.05 per share. This gives the company a multiple of about 15 times FFO per share, which is cheap compared to historical multiples.
Realty Income is a conservative stock with a great dividend yield. It should be a core holding for income investors.
Brent Nyitray, CFA, has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends American Tower, Crown Castle , and STORE Capital. The Motley Fool recommends Simon Property Group. The Motley Fool has a disclosure policy.