Top Investment Options Today: Realty Income Corporation versus British American Tobacco Companies
Investors hunting for high-dividend shares need to strike a delicate balance between risk and reward. Pursuing too much yield could result in owning a faltering enterprise that might ultimately slash its dividends.
A case in point is British American Tobacco (BTI -0.69%). Here's why cautious income investors might prefer to bypass this cigarette maker's 8.1% yield and instead opt for Realty Income's (O 0.13%) 6% yield instead.
British American Tobacco's troubling business trajectory
Approximately 80% of British American Tobacco's income comes from its combustible division; cigarettes account for some 98% of the volume in this division. Without a doubt, it's a tobacco company.
British American Tobacco's cigarette volume fell by 6.8% during the first half of 2024 (the company reports semiannually, making this the most recent volume data available). This marks a continuation of a long-term trend. Volume decreased by 5.3% in 2023, 5.1% in 2022, 0.1% in 2021 (a year that benefited from pandemic uncertainty), 4.6% in 2020, and 4.7% in 2019.
When the best volume year over the past five is a mere 0.1% increase, it's clear there's a significant business concern. This is primarily why the dividend yield is so high.
Like its cigarette competitors, British American has compensated for the declines with price hikes, enabling it to maintain its substantial dividend. However, it seems likely that further price increases will only exacerbate the volume decreases. Dividend investors likely won't wish to hold the company at that juncture, as the dividend might become unsustainable rapidly.
Realty Income's reliable business model
Essentially, purchasing the cigarette maker involves a risky wager that the company can continue to support its dividend despite the long-term decline of its primary business. Purchasing Realty Income, on the other hand, is a bet that the company can continue to expand and maintain or increase its dividend, just as it has for three decades.
To be fair, Realty Income, a net lease real estate investment trust (REIT), is a fundamentally different business than British American Tobacco, but it too offers an enticing yield.
As a REIT, Realty Income's business model is designed to distribute income to shareholders. Part of the reason for the high yield is due to this structure.
That said, net leases, which require tenants to cover most property-level operating expenses, offer a spread-investment opportunity. Interest rate volatility has made the near-term business environment a tad more challenging, which further explains the high yield.
However, the core business remains strong, with Realty Income estimating that there's an over $12 trillion addressable market at its disposal. Although it is currently the largest net lease REIT, with a market cap of $46 billion, there appears to be plenty of room for growth.
Realty Income's track record is commendable. For instance, its dividend has been increased annually for three decades, which would not be achievable if its business model were flawed or in decline.
The company has also demonstrated a robust performance, maintaining an occupancy rate of 96% even during the Great Recession's darkest days. Moreover, the company continues to invest in its future, having invested $2.1 billion in property acquisitions through the first nine months of 2024.
To be fair, Realty Income may not be as swift or dynamic as it once was, given its size. Indeed, to make a significant impact on its top and bottom lines, it requires a substantial volume of acquisitions.
However, it is still growing, and its core business remains robust. Its high yield is, therefore, far more appealing than the even higher yield offered by British American Tobacco, a company whose core business appears to be deteriorating.
Be cautious with your selections
The S&P 500 index (^GSPC -1.07%) is yielding around 1.2% today. As a result, both Realty Income and British American Tobacco are high-yield stocks. However, they represent vastly different degrees of risk, thanks to the underlying businesses supporting their lofty yields.
There's no indication that British American Tobacco's dividend is currently facing an imminent risk of being reduced. However, the long-term risk the dividend faces due to the persistent decline of its tobacco operations should not be disregarded. A dependable, steadily growing industry leader like Realty Income, despite offering a slightly lower yield, is likely to be a better choice for most income investors.
Despite British American Tobacco's high dividend yield of 8.1%, its declining cigarette volume and reliance on price hikes to maintain dividends might make it a risky investment in the long term. On the other hand, Realty Income, with a more reliable business model and a lower yield of 6%, has shown a consistent track record of dividend increases and growth potential, making it a potentially safer choice for income investors looking to balance risk and reward in their finance and investing endeavors.
