WHERE’S MY CHECK?
Why worry whether the S&P 500 is still on its way up or ready to retreat – when what you own keeps cutting you checks month after month?
By Neil George
Having regular checks coming in buys a whole lot of patience when it comes to a bad market.
With too many folks trying to guess or hope that the market has bottomed – the real way to prepare yourself for if and when they’re wrong is to make sure that you own enough of a base of stocks that pay you to own them.
Dividends are one of the surest means to make this all happen. And it doesn’t matter what age you are or where you are in your investment career – as everybody, and I mean everybody needs a large base of cash paying stocks for their portfolios.
Right now, there are lots of folks that are looking at some of the economic data of the US and trying to make the case that the worst is behind us. Even the May jobs data is being cited as evidence that things are better because only 345,000 folks supposedly lost their jobs rather than the expected or anticipated 520,000.
And with some surveys of the businesses including the ISM showing a slight up-tick along with consumers showing similar upticks in sentiment – there are folks that are calling on the National Bureau of Economic Research (NBER) to make the call that the recession is somehow over.
On the market front – no one is debating that the S&P 500 is at least for now in positive territory so far this year. But the key thing is what will keep it gaining rather than retreating.
For me – I can’t make bets on that with serious cash. Instead, I like you need to keep owning steady cash generators so that if the S&P keeps up with its long term history of crummy performance that I’ll still be able to keep paying my bills.
One of the groups of stocks that I have been writing about for many years and recommending that continue to pay you to own them are publicly traded partnerships or PTPs.
And in particular – I’ve been recommending two partnerships since I started my new publications in February that are doing exactly what you and I need for our own portfolios.
They are Linn Energy (NSDQ: LINE) and Enterprise Products Partners (NYSE: EPD).
These are on two sides of the energy market. Linn produces oil and gas from lower cost fields while Enterprise Products processes and transports petrol and its derivative products.
Linn and Enterprise have outgunned the S&P so far this just past the start of this year. Linn has a return of over 29 percent – while Enterprise has delivered a return of over 18 percent. This compares quite well even to a bounce in the S&P by muliples.
And along the way – dividends are solid and haven’t budged for Linn paying 63 cents quarter after quarter for the past year – and up from the prior years equating to a yield of over 12 percent.
Meanwhile, Enterprise being the ideal middleman in the petrol market keeps upping the payments currently running at around 54 cents giving you and I a yield of around 8 percent.
The key of course is that these partnerships have solid assets that keep generating cashflows. They have stress-tested balance sheets and successful game plans for keeping credit when they need it. And all along the way – even when petrol is that profitable for most – they keep chugging along.
These might be new to you – but they shouldn’t be for that much longer. For some of you that haven’t bought into a partnership I’ll go through the basics.
Partnerships also known as PTPs (Publicly Traded Partnerships) and/or MLPs (Master Limited Partnerships) are stock shares that trade on the major exchanges including the New York Stock Exchange (NYSE) like Enterprise or Nasdaq for Linn.
Unlike regular corporations with publicly traded stock, partnerships don't pay any corporate-level tax – rather they effectively pass through the majority of their profits to investors in the form of dividends.
Partnerships raise capital by issuing shares that are also called units. To qualify for partnership status in the US market – a partnership must receive at least 90 percent of its income from qualifying sources that can include a wide variety of businesses ranging from energy and other resources to real estate, infrastructure and a host of other heavy capital intensive industries and businesses.
Partnerships mostly are made up of two basic entities - limited partners (LPs) and a general partner (GP). When you buy a share in a partnership you become an LP owner - entitling you to the cash distributions that come from the basic operation of the partnership business. And of course – just like with a ownership of shares in a regular corporation – LP owners do not actively manage or control the assets of the partnership.
The management of a partner is done by the GP – just like management of a regular corporation is done by the guys in the executive suites and boardrooms of regular traditional public corporations.
For Partnerships - GPs are paid for running the operations for LP owners in two ways.
First, most GPs also own LP units and receive cash flows just like any investor.
And second - GPs earn what's known as an incentive distribution or dividend for their management duties.
The effect of the incentive distribution deal is that the higher the dividends paid to LP shareholders - the higher the management fee paid to the general partner. The idea behind this is that the GP has an incentive to try and boost distributions.
The bottom line is that partnerships simply another form of incorporating that enables companies with steady cash generating businesses to efficiently raise capital and distribute profits to us regular shareholders.
Now, some of you might have bought into a partnership or two way back in the ‘70s and ‘80s and have a bad memory of the experience.
As always – the US tax code isn’t always well put together and is fluid over time resulting in opportunities and pitfalls for those caught on the wrong side of Congress’ fiscal whims.
Back a quarter century ago the US tax law set up a great ride for the charlatans of the brokerage industry. Under the old IRS tax code – partnerships were able to pass through lots of depreciation and passive losses which not only could count against partnership revenues for tax liabilities – but also for other passive and in some cases active incomes for shareholders of partnerships.
This led to some wild times and way too many abuses. The result was that Congress finally stepped in and ended the fiasco and changed the laws that disallowed using the phantom tax losses against other non-partnership tax liabilities.
This meant that scam partnerships that were sold to shelter other income become worthless or even a liability for investors. And with all of the bad ones overshadowing the quality ones – the market went through the wringer and scams were outted, lawsuits filed and settled. But the genuine quality partnerships that weren’t just tax scams went on and continue to provide solid performance for investors.
Moving forward we now have a long history of tax law that has enabled quality partnerships to thrive with investors profiting and Uncle Sam getting his cut as well.
Now Partnerships do not pay corporate taxes like regular common stock companies as the profits are passed directly to shareholders that then have to pay tax on the dividends. This avoids the double-taxation of profits that has continued to be part and parcel of a regular common stock corporation.
In addition to not being subject to double taxation – depreciation also works to reduce the shareholder’s tax liability.
In the annual tax statement from the partnership’s GP and reported by your broker, bank or trust company will show the gross amount of the dividends that were paid to you as well as how much of the payment is made up of a depreciation allowance which can amount to as much as the majority of the dividends.
This is considered a return of capital by Uncle Sam and thus reduces the amount of income that is taxable. The catch is that the amount of the return of capital reduces your cost basis of your shares which then comes into play on any capital gains that you might and hopefully will have when you sell your shares in a partnership.
The statements of the dividend income and the depreciation comes not in the form of your regular 1099s - but rather in another very similar form called a K1. But just like with your 1099s – these should just go on to your accountant/taxman with usually no more fuss than with any other investment income tax reporting.
The key of course to all of this is that good partnerships are structured to cut you in on the profits much better than a regular common stock corporation and why they’re perfect for investors that like me want to own stocks that pay you to own them month after month and year after year.
Finally, some or many of you know that I was on the debating teams of my prep school and college. And while I was pretty good – I was no where even remotely close to the skills and victories of a man that died suddenly at 69 years.
Frank Harrison was on my college’s debate team and took it all the way to the National Championship in 1960 along with the help and guidance of a former fellow mentor of mine as well - Bob Connelly who died years ago.
Frank would capitalize on his debate training and experience to become a highly successful attorney as well as a member of Congress. And along the way he helped to serve many including his fellow debating team members that would follow him and his many friends including my father as well as his constituents.
His sister has noted that for anyone that might have known Frank that memorial contributions should be made to the Trinity University Debate Program, Department of Speech and Drama, One Trinity Place, San Antonio, Texas 78212-7200, attention Jarrod Atchison (www.trinity.edu) where Frank directed his own team for many years.
Neil George is editor By George and Stocks That Pay You.
The above is only opinion and does not represent and/or offer to buy or sell any security and/or any financial advice. The opinions contained may not be suitable for all investors who should consult their own financial adviser before making any investment or other decisions. I may own some of these same securities noted in accounts under my control or for my benefit.
Errors/Omissions: I always welcome being called on facts, figures and commentary from readers and look forward to your feedback. I can be reached by email at firstname.lastname@example.org or email@example.com or at 01-314-616-3325.