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What
does a company do -- and can the country operate without
it?
That's a critical question for investors to ask these
days, as many experts predict consumers will pare
discretionary spending as the world faces
a potentially lengthy downturn.
Businesses that do well in any economic climate are known as
"defensive" plays, and they're back in vogue. Growth-oriented
investing isn't dead, but many investors are
looking for a less-aggressive strategy, one that focuses on
asset protection and income generation.
After all, no one needs a Harley, but people will
always need medicine and electric power. That's why
indispensable companies -- whose products or services the nation can't do
without -- are typically at the foundation of a defensive
portfolio.
My favorite asset class in the defensive space provides
an absolutely vital service -- something without which
America would grind to a halt. The industry
is known for its higher-than-average yields and
has recorded steady distribution increases for not just years, but
decades. And on top of all that, this asset class
provides a high degree of safety. As the S&P 500 looks to
post a wide loss for the year, many of the companies in this
industry will show a gain -- even before their rich payouts
are factored in.
I know you may be
thinking that such a trifecta of positives is impossible in
this market, but it's not. You might be able to find
companies with more interesting products, but for sheer
safety, stability and sustainable payouts, it doesn't get
any better than master limited partnerships.
. .
What Master Limited
Partnerships Are -- And What
They Do
A partnership is simply a type
of legal entity. In most cases, partnership shares are
owned by individuals who are engaged in the entity's
business -- like a law firm. Unlike a corporation, the partnership itself doesn't pay income
taxes, the partners do. A "master limited partnership"
is simply a partnership that is divided into shares, called
"units," which are then sold to the public. It works to the same effect as a
corporation: The only real difference is taxation.
This structure has been embraced most strongly by the
energy industry. Master limited partnerships, which
often go by their acronym, MLPs, typically own pipelines or
oil and gas wells. These entities generate cash from
producing petroleum or receive fees based on the
amount of product shipped through their networks. The partnership
administers the business and ships the profits home to the
owners.
MLPs Offer Higher-Than-Average
Yields
With all that cash being generated from such an essential
business, it's no wonder MLPs have extremely high
yields -- yields of 8%, 10%, even 16% are not uncommon. The average yield of the Alerian MLP Index is 9.4%,
roughly three times higher than the current 3.4% yield of the S&P
500.
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Over time, such a high
yield is a game-changer.
As the chart to the right shows, a 3.4% yield barely affects the balance
of a $10,000 investment -- even over the
span of 20 years, that paltry rate of return is
likely to be wiped out by inflation and taxes.
For the prudent
MLP investor, the picture is far different.
After 20 years of reinvestment, a 9.4% dividend
yield magnifies the same $10,000 into $60,304 -- and that's before you factor in any
capital gains!
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But that's only part of the equation. To wit: In 2007, MLPs delivered average
total returns of +12.7%, handily beating the S&P 500's total
return of +5.5%. And over the long run, the picture is even
better -- MLPs in the Alerian MLP
Index returned an astounding +17.3% per year between 1997
and 2007. (I just can't help myself here: Over 20
years, that rate of return -- that historical average return
-- turns $10,000 into $243,200. Why not let MLPs send one of your children or grandchildren to
college?)
MLPs Increase
Their Payouts Over Time
Believe it or not, the MLP picture just keeps
getting better for income investors. That's because
MLPs have a strong track record of hiking their payouts.
They can't keep the money around: They're legally obligated
to pass it along to the partners. Take a look at what
this has meant for one of my favorite MLPs. The chart below shows
the amount of its quarterly distribution per share since 2002.
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As
you can see, this 7.8%-yielding MLP is totally focused on taking care of
its shareholders: It has never once decreased its
distribution. That's crucial -- in the current market, the
most recent data from Standard & Poor's shows that 36
companies in its 500 Index have cut or suspended dividends
46 times so far in 2008 -- taking $33.3 billion out of
investors' pockets.
But MLP payments have been steady, dependable and,
in many cases, even on the rise. Sure, energy prices
swing, sometimes dramatically, but the nation's crude oil,
gasoline and natural gas continues to move, and that is how
most MLPs make their money.
Strong Performance in a Tumultuous Market
What does all that add up to? MLPs are schooling the
market. The price performance of the same MLP we featured in the
chart above is depicted
below. This security is up some +15% on price appreciation
alone, as the S&P has faltered nearly -35% since January 2007.
This shows an absolutely unmistakable vote
of confidence for MLPs in this market -- a crystal-clear
signal that serious income investors simply cannot afford to
ignore.
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Now, even though my favorite MLP has seen positive price
performance, some MLPs are down. That's because many
own "upstream" assets, which is insider jargon for producing
wells. The concern is that these entities will see less
revenue because the price of oil has fallen. But in many
cases, the per-barrel recovery cost is still quite low,
perhaps less than $10 a barrel for crude oil, for example.
And while it's nice to be paid $140 for something that cost
you $10, receiving $60 or $70 is a long way from being a
losing proposition.
Still, the majority of MLPs make their money by shipping and
storing oil, gasoline and natural gas. They'll continue
making money as long as there is demand for energy. A
pipeline is more comparable to a toll bridge than an oil
company -- customers must pay to get from one side to the
other. The value of the cars going over the span
doesn't really matter. After
all, most MLPs make money based on how much product gets
moved through their system, not the actual value of that
product.
And
while many of these securities have fallen out of sympathy
for the market, Income investors should take note -- and full
advantage -- of this temporary price reduction. This
sale, and stable yields reaching as high as 16%, won't last
long.
How to Profit From MLPs
Carla Pasternak, editor of
High-Yield Investing, has been an avid devotee of
MLPs for years. In fact, her "Dividend Optimizer"
Portfolio, available only to subscribers, even has an entire
section allocated to this asset class.
Given their performance, it's obvious why Carla is so
fond of these partnerships. Energy-related MLPs offer rich
yields and provide
shelter during market storms. Their earnings are protected
by the necessity of their product. Despite all the talk
about alternative energy, the United States is still
dependent on fossil fuels, and moving them around the nation
is a vital element of the economy that we simply
cannot do without. Someone is going to make money from that,
and there's no reason why one of those fat dividend checks
shouldn't have your name on it.
To
find out more about how Carla can show you how to use MLPs
to propel the performance of your income portfolio
(including the name of my favorite MLP I featured above),
visit
this link.
Thanks for joining me on my search for
today's highest-yielding securities!
-- Andy Obermueller
Co-Editor
Global Dividend Opportunities
GlobalDividends.com
839-K Quince Orchard Blvd.
Gaithersburg, MD 20878-1614
P.S.-- Don't miss a single issue! Add our address,
Research@GlobalDividend.com,
to your Address Book or Safe List. For instructions, go
here.
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