Realty Income Corporation (NYSE:O) Stock Is Going Strong But Fundamentals Look Uncertain: What Lies Ahead ?

Realty Income (NYSE:O) has had a great run on the share market with its stock up by a significant 13% over the last three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Specifically, we decided to study Realty Income's ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Realty Income

How To Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Realty Income is:

2.1% = US$564m ÷ US$26b (Based on the trailing twelve months to June 2022).

The 'return' is the yearly profit. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.02 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Realty Income's Earnings Growth And 2.1% ROE

It is hard to argue that Realty Income's ROE is much good in and of itself. Even compared to the average industry ROE of 6.5%, the company's ROE is quite dismal. However, the moderate 8.0% net income growth seen by Realty Income over the past five years is definitely a positive. Therefore, the growth in earnings could probably have been caused by other variables. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

We then compared Realty Income's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 11% in the same period, which is a bit concerning.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Realty Income's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Realty Income Making Efficient Use Of Its Profits?

Realty Income seems to be paying out most of its income as dividends judging by its three-year median payout ratio of 84%, meaning the company retains only 16% of its income. However, this is typical for REITs as they are often required by law to distribute most of their earnings. In spite of this, the company was able to grow its earnings by a fair bit, as we saw above.

Additionally, Realty Income has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 76% of its profits over the next three years. Regardless, the future ROE for Realty Income is predicted to rise to 3.6% despite there being not much change expected in its payout ratio.

Conclusion

In total, we're a bit ambivalent about Realty Income's performance. While the company has posted a decent earnings growth, We do feel that the earnings growth number could have been even higher, had the company been reinvesting more of its earnings at a higher rate of return. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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