MLPs: Better Than Dividend Stocks for Income Investors?

by Mike Kapsch, Investment U Research
Wednesday, May 23, 2012

As income investors scour the market for higher yields, a number of them are (in fact) shifting their attention from dividend stocks to MLPs like EPD and ETP.

Last December, Investment U Senior Analyst Marc Lichtenfeld made some bold predictions for income investors in 2012.

Perhaps his biggest was that Apple (Nasdaq: AAPL) would declare a dividend. Of course, in March, Apple did just that.

Another prediction was that master limited partnerships (MLPs) would be one the hottest investments this year.

Marc pointed out, as dividend stocks become more popular, their overall yields will go down. As a direct result, investors will widen their search for income and end up in MLPs.

MartketWatch reported just a few days ago, ?In 2012, S&P 500 companies are on pace to pay out a record amount in dividends ? $277 million or about $29.02 per index share.?

What does this tell us?

It?s that dividend paying stocks are more popular than they?ve been in a very long time, if ever.

And as investors scour the market for higher yields, a number of them are (in fact) shifting their attention to MLPs.

The Good? the Bad? and the Easy Way

It?s doesn?t take much to see why MLPs are gaining in popularity today?

• The average dividend from the S&P 500 yields just about 2%.
• 10-year Treasuries pay less than 2%.
• And money market accounts return next to nothing.

Meanwhile, MLPs like Enterprise Product Partners (NYSE: EPD), Energy Transfer Partners (NYSE: ETP), and Regency Energy Partners (NYSE: RGP) yield 5%, 7%, and 9% respectively. Returns from other MLPs can be even higher.

Because MLPs redistribute at least 90% of their income back to investors (known as unit holders), they typically have higher yields than regular dividend paying stocks.

But there?s a second reason more investors are looking into them as well? taxes.

You see, distributions from MLPs offer a unique tax advantage because a portion of their payouts is considered a ?return of capital,? not a dividend.

Therefore, unit holders are not taxed on their return of capital until they go to sell their holdings.

Now if this sounds enticing and complicated all at the same time, you?re absolutely right.

And this is exactly what makes MLPs good for some and bad for others. I?d say, unless you know what you?re doing, you should consult a tax advisor before investing a dime in any MLP.

But is there any way to enjoy higher yields from MLPs without the tax headaches?

Yes. And the answer for you may be in ETFs.

MLP ETFs

Something you?ll quickly notice about MLPs is that nearly all of them are companies involved with the storage and transportation of commodities such as oil or natural gas.

Not surprisingly, MLP ETFs are also comprised the same way.

For instance, Alerian MLP Infrastructure Index ETF (NYSE: AMLP) contains 50 prominent energy-related MLPs in its fund.

Typical of individual MLPs, Alerian also has a juicy yield of 6%. But unlike regular MLPs, it?s structured like a C-corp and is required to pay state and federal income taxes.

In other words, while you?ll have higher income and less headache to deal with at tax time by investing in an MLP ETF, you will also pay taxes and fees on the fund just like you would investing in any other dividend generating ETF.

Alerian has an expense ratio of 0.85%. Among MLP ETFs, the average expense ratio is 0.88%. But this number was just slashed by a new ETF, Global X MLP ETF (NYSE: MLPA), which just launched a little over a month ago. Its expense ratio is just 0.45%.

Looking Forward

No matter how you look at it, MLPs are increasingly becoming a popular way to invest among savvy investors. But if you?re not one for getting involved in their complicated tax structures, you may want to consider an MLP ETF as an alternative. With interest rates to remain low at least until 2014, you?re going to be hard pressed to find a more solid yield for your investments.

Good Investing,

Mike Kapsch

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