You know the power of dividend investing. The allure of guaranteed quarterly payments, the stability of cash-rich businesses and compound interest over time as you reinvest your dividends in your portfolio are all enticing.
But a lot of dividend charlatans are out there cutting or eliminating payouts. There are also volatile payers that show up with 10% annualized yields in Google Finance or Yahoo! Finance based on last quarter’s payout annualized — but in reality, these stocks are seeing dividends slashed at each passing payout.
So, to help you dividend investors out there, I’m shining a light on an obscure but dividend-rich segment of the market: “master limited partnerships,” or MLPs.
MLPs combine the tax benefits of a limited partnership with the liquidity of a publicly traded security. This special type of partnership helps reduce the burden of costly enterprises such as building oil pipelines — an in exchange, requires the partnerships to pay all of their profits back to “unitholders” in the form of “distributions.”
Jargon aside, these are typically energy-focused companies with a legal mandate for big dividends. Here are three red-hot MLPs you should consider adding to your portfolio:
Linn Energy — 7.4% Yield
Linn Energy (NASDAQ:LINE), unlike other MLPs that simply transport energy, is actually involved in production. But unlike some “depletion” partnerships that have a finite amount of fossil fuels to pump out of the ground, Linn is committed to acquisitions as well as output.
This business model obviously has risks because Linn is exposed to commodity prices. However, it actively hedges through derivative instruments — and much like savvy fuel hedging at airlines can mitigate high energy prices, good strategies at Linn can prop up profits even in lean times.
The ultimate hedge, at least in the long term, is Linn’s strategy of aggressive acquisitions. The firm has taken advantage of cheap natural gas prices and made $3.4 billion worth of acquisitions in the past year. That’s because natural gas hit a 28-month low in January 2012 after crashing all last year. The time was ripe for buyouts in 2011, so Linn acted.
Of course, earnings have been volatile because of the mix of buyouts, hedging and production fluctuations. But look at the revenue to see the story: Linn cleared $414 million in fiscal 2009 and almost tripled that to nearly $1.2 billion in fiscal 2011.
That was with crashing gas prices, and that was before many of these recent acquisitions. Just imagine how revenue will continue to move up sharply in years to come.
Linn stock is near an all-time high but has bright future prospects. But even if it drifts sideways for a while, the juicy (and sustainable) 7.4% yield is reason to give LINE a look.
Enterprise Products Partners — 4.7% Yield
A natural gas MLP worth exploring is Enterprise Products Partners LP (NYSE:EPD). The company is riding 10 consecutive quarters of year-over-year revenue growth. Its fiscal 2011 earnings more than doubled 2010 numbers, surging to above pre-recession levels, and Enterprise Products has a five-year growth rate of over 16% annually.
Also note the dividend history. The company has had 33 straight quarter-over-quarter increases to its distributions. You’ll have to go all the way back to 2004 to find a dividend that didn’t move up next time. The increases are modest, but powerful over time. Distributions have increased 27% since the beginning of 2008 and 70% since 2004. Its last distribution was 63.5 cents — giving the stock an annualized yield of 4.8%. But that could keep moving higher if the history of increases continues.
This is the kind of info that would make any company attractive to investors.
Enterprise Products is a leader in so-called “midstream” infrastructure in the deepwater of the Gulf of Mexico. The “upstream” part is the actual production of energy by drilling companies and oil service stocks. “Downstream” activity involves delivering natural gas to end users. EPD is the middleman, taking a cut along the way. There’s no competition or commodity cost shock, limiting risk for investors.
Plains All-American (PAA) — 4.9% Yield
Plains All-American Pipeline (NYSE:PAA) makes its money via storage and transport of crude oil and other energy products. But its biggest competitive advantage is its partnership with top players in shale oil fields. From the Permian Basin to the Bakken Shale to Eagle Ford and Mississippian Lime, Plains is connected to them all.
Of course, while Plains All-American does not produce oil and is not exposed directly to commodity prices, it’s worth noting that the more costly nature of shale oil (as opposed to more easily extracted oil from conventional wells) can severely limit production from these regions. If oil prices are too low — below $80 or so — producers are basically breaking even on their output, so there’s no incentive to pump like crazy. Thus, less fuel flowing through PAA distribution facilities, and lower revenue.
However, that risk only makes Plains more attractive when you consider its great revenue and earnings performance even as oil prices have remained relatively modest for the past year or two, never breaking above $100 a barrel for more than a few weeks at a stretch.
Just look at the numbers. It has raised distributions eight times in a row — and hasn’t seen a quarter-over-quarter reduction in over 12 years, dating back to early 2000! The current yield for the stock is 4.9% based on its August distribution of $1.065 a share.
Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at email@example.com or follow him on Twitter via @JeffReevesIP. As of this writing he did not own a position in any of the stocks named here.