Could Buying Realty Income Stock Today Set You Up for Life?

Some dividend stocks are famous throughout the investing community, and Realty Income (NYSE: O) is one of them. It refers to itself as "The Monthly Dividend Company," a nickname geared toward the investors who use its monthly dividend payouts to help pay their living expenses.

Dividends are the primary draw for most Realty Income shareholders, but don't underestimate the stock's ability to generate life-changing wealth. The stock's lifetime (since 1994) total returns exceed 5,000%, more than double the S&P 500's returns over that time.

Can Realty Income still set you up for life? I think so. However, it might take some planning to maximize the stock's performance. Here is what you need to know if you want Realty Income to help you build a fortune.

The key to unlocking Realty Income's potential

Realty Income is a real estate investment trust (REIT), a company that acquires and leases real estate. This company is a net lease retail REIT specializing in single-tenant properties, such as grocery stores, restaurants, convenience stores, and other places where people frequently spend time and money.

REITs must distribute at least 90% of their taxable income to shareholders. That generally makes REITs a great place to find dividends. Realty Income currently yields an impressive 5.5%, and management has increased its dividends for 31 consecutive years -- every year since going public.

Those dividends, or more specifically, reinvesting those dividends, are the key to getting the most out of the stock. Reinvesting the dividend buys you additional shares, which also pay dividends. It's like a dividend snowball that gets bigger and faster as it rolls downhill.

Three things make Realty Income extra good for reinvesting dividends:

1. Its high starting dividend yield.
2. It pays monthly, which increases the compounding frequency.
3. The dividend is continually growing (108 consecutive quarterly raises).

Notice the difference below between Realty Income's returns from price appreciation alone and total returns.

O data by YCharts.

Realty Income can set an investor up for life, but only if they reinvest the dividends and wait long enough for that dividend snowball to grow big enough.

Here is something you may not have considered

There's some fine print that I think you'll want to read.

American investors pay a tax rate between 0% and 20% (depending on your income) on qualified dividends. However, dividends from most REITs, such as Realty Income, are nonqualified. They're taxed as ordinary income instead. In other words, you'll pay whatever your tax bracket is, which could be as high as 37% in the United States.

People generally don't think much about taxes when they're just starting their investing journey, but taxes can equate to thousands of dollars annually as investments grow. If you want to build your dividend snowball with Realty Income, consider doing it in a tax-advantaged account, such as a Roth IRA.

Anyone who isn't a U.S. investor or is unsure how tax laws may affect their finances should consult a tax professional.

Can Realty Income's dividend still grow?

Want Realty Income (as part of a diverse portfolio) to help set you up for life? Here is the playbook: Dollar-cost average into Realty Income, hold the stock, and reinvest the dividends.

But this doesn't work unless Realty Income continues growing. It's already one of the largest REITs on the market, with over 15,000 properties across the United States, Europe, and the United Kingdom. Companies can borrow money or raise their dividend payout ratio to juice the dividend, but that's only temporary. Over time, a company's underlying growth dictates the dividend.

Realty Income's dividend is well-funded, with a payout ratio of 75%. Additionally, the company has grown its dividend at an annualized rate of 4.3% over its lifetime. In pursuit of growth, the company has begun tapping new property markets, such as industrial properties, data centers, gaming properties, and more.

Doing new things can be risky, but Realty Income's track record (the company hasn't shown an operating loss in nearly 30 years) should probably earn some trust from investors until proven otherwise. Analysts expect the business to grow between 3% and 4% annually over the next three to five years. A healthy payout ratio and likely dividend growth ahead mean investors can continue to build their dividend snowballs with Realty Income stock.

Should you invest $1,000 in Realty Income right now?

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Justin Pope has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Realty Income. The Motley Fool has a disclosure policy.