Most analysts love Realty, which has an average rating of buy. But there's reason to believe the stock may be overvalued at today's price of $64.74 per share. Let's look at the fundamentals ourselves and see if we reach a different conclusion than the analyst community.
Traditionally, value investors would look for companies with a ratio of less than 1 (meaning that the market value was smaller than the company's book value), but such opportunities are very rare these days. So we tend to look for company's whose valuations are less than their sector and market average. The P/B ratio for Realty is 1.517, compared to its sector average of 2.24 and the S&P 500's average P/B of 2.95.
Modernly, the most common metric for valuing a company is its Price to Earnings (P/E) ratio. It's simply today's stock price of 64.74 divided by either its trailing or forward earnings, which for Realty are $1.41 and $1.44 respectively. Based on these values, the company's trailing P/E ratio is 45.91 and its forward P/E ratio is 44.96. By way of comparison, the average P/E ratio of the Real Estate sector is 24.81 and the average P/E ratio of the S&P 500 is 15.97.
The problem with P/E ratios is that they don't take into account the growth of earnings. This means that a company with a higher than average P/E ratio may still be undervalued if it has extremely high projected earnings growth. Conversely, a company with a low P/E ratio may not present a good value proposition if its projected earnings are stagnant.
When we divide Realty's P/E ratio by its projected 5 year earnings growth rate, we obtain its Price to Earnings Growth (PEG) ratio of 4.321. Since a PEG ratio between 0 and 1 may indicate that the company's valuation is proportionate to its growth potential, we see here that O is overvalued when we factor growth into the price to earnings calculus. One important caveat here is that PEG ratios are calculated on the basis of future earnings growth estimates, which may turn out to be wrong.
Investors are undoubtedly attracted by Realty's dividend of $4.78%. But can the company keep up these payments? Dividends are paid out from levered free cash flow, which is the money left over after the company has accounted for all expenses and income -- including those unrelated to its core business. In Realty's case, the cash flows are negative which calls into question the firm's ability to sustain its dividends.
Analysts are bullish on Realty, but we are concerned they may be missing the clouded growth picture, as expressed by the stock's elevated PEG ratio. In addition, many of its valuation metrics point to a stock with an inflated value. We will keep following O to see whether the analyst community was right.
