As many analysts predict slower economic growth or a "new normal" in the years ahead, high dividend stocks could replace growth stocks as the new darlings of the market in a muted expansion.
And recently, they have gotten cheaper. But one type of dividend stock should be particularly successful.
MLP Index has returned more than +400% with dividends reinvested during the past 10 years. The S&P 500's return is negative during the same period.
In the past month, crude oil prices have plummeted from $85 a barrel to just more than $70 a barrel. And, MLPs (which are comprised mostly of energy companies) have taken a beating. The Alerian MLP index is down about -9.5% from the highs of April.
Going forward, MLPs could continue their long-term winning streak.
MLPs are structured in such a way that they pay no taxes at the corporate level provided they pass the bulk of taxable income on to shareholders in the form of distributions. The ability to pass on income that would have otherwise been lost to taxes gives MLPs an edge as great income stocks.
Energy Income and Growth Fund (FEN) is a closed-end fund comprised primarily of energy sector MLPs. Buying MLPs through a closed-end fund rather than individually has two distinct advantages. First, you get a diversified portfolio which greatly reduces the risk of any one particular company. Second, unlike individual MLPs, the fund is classified as a corporation for tax purposes and doesn't generate a K-1 form or unrelated business taxable income (UBTI), which can be taxable in an IRA.
FEN must invest at least 85% in the energy sector and at least 65% of that in energy MLPs. The fund has about 80% of the portfolio invested in midstream oil and gas MLPs. The fund had about 52% of assets invested in its top-10 positions, which included Magellan Midstream Partners LP (NYSE:MMP), Enterprise Products Partners LP (NYSE:EPD) and Plains All American Pipeline LP (NYSE:PAA).
The best thing about MLPs is the income they generate. FEN pays quarterly distributions, which were just raised to $0.445 a share from $0.44. The fund yields almost 8.0% at recent prices. How many investments pay that kind of income and still offer capital appreciation?
The fund's historical performance has been excellent. FEN returned an average of about +8.4 % a year for the past five years, and returned about +10.6% a year since the fund's inception in June 2004. The S&P 500 has had a negative return for both periods.
Slower economic activity decreases overall demand for energy as businesses and individuals cut back. And lower energy demand means less business for midstream MLPs' storage and transportation facilities. However, market concern about a slowing recovery might be overblown. The International Monetary Fund (IMF) raised the 2010 economic growth forecast in late April to +3.1% from a previous +2.7%. Barclay's Capital predicts +3.4% growth in the United States for 2010 despite the European debt crisis.
Action to Take ------> FEN is an easy way to take advantage of the phenomenal opportunity in MLPs. High yields with growing earnings over the longer run might be exactly what the doctor ordered in the slower growth environment we may see during the next several years. FEN is down more than -14% since late April amid the overall market selloff and has created an excellent entry point for investors.
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