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As you know, I think stockholders deserve to get their fair share of a company’s profits. And that’s why I love investing in companies that not only make substantial distributions to their shareholders, but are legally bound to do so.
Today, I want to tell you about one such group of stocks, known as Master Limited Partnerships (MLPs). If you’re an income investor looking for big dividends, you can’t afford to ignore these investments …
Why Master Limited Partnerships
Are Your Pipeline to Profits
The typical company is a plain old corporation, a separate legal entity from its employees and investors. They’re treated as separate legal entities come tax time, too. Thus, if shareholders receive dividends, they’ll eventually pay taxes on the income, too.
That’s why some companies choose to organize as partnerships, which are not considered separate legal entities. In other words, the partners are liable for the obligations of the partnership but also get all the direct benefits.
The kind of partnerships I want to tell you about today are called Master Limited Partnerships (MLPs), also known as publicly traded partnerships (PTPs).
Before you start having flashbacks of the limited partnerships from the 1980s — the ones that left a lot of investors high and dry — rest assured, these are entirely different and they don’t carry the same level of risk.
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| I consider MLPs a pipeline to profits because of their fat dividend distributions. |
Here are four important facts you need to know about MLPs:
#1. Only certain kinds of companies can qualify for this special status. At least 90% of the company’s income must come from certain sources such as interest, real estate rents, gains on commodities, and revenue from activities related to natural resources. You’ll find a lot of MLPs that own stuff like timberland or oil pipelines.
#2. They are publicly traded … with a twist. Most MLPs trade on the New York Stock Exchange and you buy them in a regular brokerage account just as you would buy a stock. Technically, though, you’re purchasing “units” rather than “shares.” When you buy these units, you become a partner.
#3. Your liability is generally limited. I mentioned that in a partnership, everyone is part of the same legal entity. So you’re probably wondering whether buying units in an MLP opens you up to all kinds of risks. Not really. That’s because you’ll become a limited partner, which means your liability is, well, limited.
Note, however, that you do not have the exact same protections as shareholders of a public corporation. For example, creditors can come after limited partners’ distributed capital in certain instances. Similarly, limited partners could also be liable for taxes. I wouldn’t lose sleep over these situations because they’re fairly remote possibilities, but you should be aware of them.
#4. These partnerships are “pass-through” entities. As I said a moment ago, corporations pay taxes and then their shareholders who receive income pay taxes again. With partnerships, all the income is treated as if it is earned by the partners and it is allocated to them based on their individual stake. The partners also share in any other events that typically affect taxable income such as deductions and credits.
And now the best part …
You Will Get Very Generous Regular Quarterly
Distributions That Have a Special Tax Advantage!
MLPs are required by law to pay out most of their cash flow to partners in the form of regular quarterly distributions. By all appearances, these payments look like plain ol’ dividends. However, there’s an important difference at tax time — the bulk of the quarterly distributions are considered a return of capital and not taxable investment income.
Translation: Most of your distributions are tax deferred!
What happens is that the cost basis of your partnership units — the price you originally paid — gets adjusted up and down for distributions, income, and those passed-through tax items.
It’s a somewhat complicated process, so I’ll spare you the details. But suffice it to say that for most investors, there are great perks to owning MLPs.
Realistically, you’re better off holding for longer time periods. And in general, you should not hold MLPs in tax-sheltered accounts like IRAs. That’s because any amount of income that exceeds $1,000 will likely be taxable even if the MLP is held inside a tax-sheltered account.
Is it all a bit tricky? Yes. But MLPs do their best to help investors wade through the process. And it is precisely these little hurdles that keep a lot of people away from MLPs … leaving the juicy yields to those who are brave enough to sit down and get their hands dirty!
The rewards can certainly be great … many MLPs are yielding in excess of 6% a year. The ability to defer most of that income is a huge advantage. And you also stand to book capital gains along the way!
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A Sampling of MLPs …
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Name
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Ticker
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Recent Yield
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Genesis Energy LP
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GEL
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5.2%
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Williams Partners
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WPZ
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6.2%
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Copano Energy LLC
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CPNO
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5.8%
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Regenct Energy Partners LP
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RGNC
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5.4%
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Boardwalk Pipeline Partners
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BWP
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7.4%
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Energy Transfer Partners LP
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ETP
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9.4%
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Magellan Midstream Partners
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MMP
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6.0%
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Buckeye Partners
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BPL
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6.8%
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NuStar Energy
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NS
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7.2%
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Global Partners
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GLP
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7.0%
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Kinder Morgan Energy Partners
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KMP
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6.5%
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TEPPCO Partners LP
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TPP
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7.3%
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TC Pipelines LP
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TCLP
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7.9%
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Enbridge Energy Partners
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EEP
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7.7%
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Atlas Pipeline Partners
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APL
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8.4%
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Dorchester Minerals
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DMLP
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9.4%
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Four Steps You Can Take to Find
Attractive Master Limited Partnerships
As you can see from my table, there are lots of MLPs trading right now. And deciding which ones are worth your investment dollars isn’t always easy.
I recommend looking at four specific criteria …
First, you want to go after MLPs that are throwing off healthy cash distributions right now. After all, the whole point of these investments is garnering above-average income.
Second, the MLP should be increasing its payments at a steady rate. That way you’ll be getting an even bigger yield on your original cost. Heck, within a few years, you could be earning a relatively safe double-digit return!
Third, the partnership needs to have financial strength. The company shouldn’t be overly indebted. It should also have plenty of cash flow to cover its distributions.
Fourth, carefully consider what kind of business the partnership is operating. As I mentioned earlier, all these companies are required to run certain types of businesses. However, some have greater risks than others.
But whatever you do, I strongly encourage you to take a look at what’s out there right now. Given the pitiful interest rates on most income investments, MLPs look mighty darn attractive!
Best wishes,
Nilus
About Money and Markets
For more information and archived issues, visit http://www.moneyandmarkets.com
Money and Markets (MaM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Tony Sagami, Nilus Mattive, Sean Brodrick, Larry Edelson, Michael Larson and Jack Crooks. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MaM, nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MaM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical in as much as we do not track the actual prices investors pay or receive. Regular contributors and staff include Kristen Adams, Andrea Baumwald, John Burke, Amber Dakar, Dinesh Kalera, Mathias Korzan, Red Morgan, Maryellen Murphy, Jennifer Newman-Amos, Adam Shafer, Julie Trudeau and Leslie Underwood.
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