The U.S. government wants you to get 7% yields, and then give you a huge tax break on your investment.
If you're like me, you're probably chuckling in amusement right now. The government ... giving away tax breaks ... on yields earned from investments? Impossible!
But it's actually 100% true. As James Early -- advisor of Motley Fool Income Investor -- clarifies: "Technically, Uncle Sam simply wants to promote energy infrastructure, but if that also means promoting our pocketbooks, we'll take it."
But it won't come from investing in dividend payers like Bristol-Myers Squibb (NYSE: BMY ) , VF Corp. (NYSE: VFC ) and ExxonMobil (NYSE: XOM ) -- despite the fact that each has paid a dividend for more than 50 years. Not to mention, they all have a growing dividends along with payout ratios and debt-to-equity ratios below 50%, so I think these dividends are secure.
And take it we will
The investments I'm referring to are "master limited partnerships," or MLPs. Back in the 1980s, Congress wanted to expand the growth of oil and natural gas pipeline facilities across the country. Since they allow citizens the right to form partnerships (which don't have to pay corporate taxes), these MLPs are able to have more money to invest in new projects, thereby advancing Congress' agenda.
But it gets even better. There's a hidden tax benefit for the individuals who own units of MLPs, which pay out nearly all their cash profits to investors -- something that isn't available to non-MLP energy stalwarts like Chevron (NYSE: CVX ) and FirstEnergy (NYSE: FE ) . Even though both of those companies have a growing dividend, manageable levels of debt, and should benefit as global energy demand has nowhere to go but up, they are still not where you'll find the best yields!
You see, because of accounting regulations, MLPs make more in cash earnings than they do in accounting earnings; it can be something like five times as much. But investors in MLPs are only taxed on the lower accounting earnings, while they receive a share of the larger cash earnings.
Now is the time to get in
The yields on MLPs are truly wonderful, even before you add in the tax benefits. MLPs frequently yield about 7%, and sometimes even higher than that. Yet most investors are missing out.
Moreover, because MLPs run monopoly like toll businesses, their cash flows are less tied to speculation than those of oil and gas companies and real estate investment trusts like Annaly Capital Management (NYSE: NLY ) and ProLogis (NYSE: PLD ) , which could both be facing even more dividend cuts in the coming year. Annaly is still heavily correlated to the mortgage market, which could be facing more trouble, and ProLogis is heavily correlated to the American industrial sector, which is still having trouble competing with Asia.
A Wells Fargo analyst recently praised MLPs for the "fee-based stable nature of their cash flows, the diversity and breadth of their assets, investment grade credit rating, and superior access to the capital markets." And the analyst's two favorite MLPs are also recommended by James in his Income Investor newsletter.
For all these reasons, James believes that MLPs will be among the best yielders for the next 10 years. Since I know you're eager to know more, I will tell you that one of the MLPs is Magellan Midstream Partners, which operates a massive pipeline system running from Texas through the Midwest, and yields 6.6%.
To see all the MLPs that James believes are fantastic investments today, I invite you to check out his Income Investor service, completely free. You can read all about MLPs -- plus his other favorite dividend payers -- and see which ones he likes, free for 30 days. Simply click here for more information.
This article was originally published Nov. 13, 2009. It has been updated.
Adam J. Wiederman doesn't own shares of the companies mentioned above. V.F. is a former Motley Fool Income Investor recommendation. Magellan Midstream is a current Motley Fool Income Investor recommendation. The Fool's disclosure policy is outlined here.