These 3 Dividends Will Solve Your 44% Problem

Since the lows of March 2009, the S&P 500 has doubled, making this one of the longest and most significant bull markets since the Great Depression. Profits have skyrocketed. Margins have improved. Cash sits on balance sheets in record amounts. Yet according to one of the most revered academics of our time, the market is substantially overpriced.

Read on, and I'll show you how to avoid pricey stocks in this potentially inflated market, and cash in on three dividend knockouts. I'll also share with you how to get free access to 13 more outstanding dividend payers, courtesy of The Motley Fool's expert analysts.

The problem … and the solution
Yale economist Robert Shiller successfully called out the tech bubble in 2000 and forecast the housing bust in 2006. Now he's making another a dire prediction: The stock market could be overheated, and it's expensive relative to its historical valuations. Shiller's method illustrates that the general market is priced at about 23 times earnings, way above the average of 16. That 44% premium could represent a huge problem.

Shiller has his fair share of critics, including Jeremy Siegel, but let's assume for the moment that he's correct about the general market. If stocks are so expensive, where can investors go to find continually positive returns?

The answer: dividends.

Companies in the U.S. are doing so well that they have almost no choice but to increase or start paying dividends in order to return wealth to shareholders. Profit margins among non-financial stocks in the S&P 500 could climb to 8.9% this year, the highest level in 18 years, according to Bloomberg. Analysts expect profits to jump 16% in 2011, and companies in the S&P 500 have a record $937 billion in cash on their ledgers.

Already, we're starting to see the positive effects of increased profits and gobs of cash ripple through a wide array of businesses. Financial stocks, forced to slash their payments during the crash of 2008, have come roaring back. JPMorgan (NYSE: JPM  ) has quintupled its quarterly dividend and announced a $15 billion buyback plan. Similarly, US Bancorp (NYSE: USB  ) boosted its dividend by 150% and announced a 50 million-share buyback program.

But banks aren't the only companies boosting payouts; industrial companies and consumer-facing businesses are getting in the game as well. Cruise line operator Carnival (NYSE: CCL  ) more than doubled its dividend last quarter, and even retailer Limited Brands (NYSE: LTD  ) found a way to take its dividend from $0.15 to $0.20.

Who cares about these dividend increases?
Dividend payments, coupled with the prospect of earnings growth, are much-coveted characteristics for any stock. It's long been documented that companies that pay dividends outperform their non-paying brethren. According to Bloomberg, companies that return the most money to shareholders have beaten the general market by 11 percentage points since the bull market began in 2009. Furthermore, shares of companies with dividends have gone up by 3.8% in 2011, while shares of companies with no dividends have only risen by 2%. That's a pretty significant difference for such a short amount of time.

To help you find great dividend-paying companies in what could be a very pricey stock environment, I've used certain attributes to uncover three dividend home run companies. Specifically, I looked at the energy sector, owning not only to surging oil prices, but also to what should be an eventual recovery in gas prices as well. I scoured the market for companies (a) paying dividends greater than 5% (b) with a history of dividend growth, and (c) maximum five-star rankings from our 170,000-member investing community.

Company

Dividend Yield

5-Year Dividend CAGR

CAPS Rating

Buckeye Partners (NYSE: BPL  ) 6.27% 6.15% *****
Enterprise Products Partners (NYSE: EPD  ) 5.48% 6.4% *****
Teekay LNG Partners (NYSE: TGP  ) 6.51% 18% *****

Source: Capital IQ, a division of Standard & Poor's.

It's important to note that these companies are set up as limited partnerships, so they typically pay out most of their cash flow from operations in the form of distributions to shareholders. Both Buckeye Partners and Enterprise Products Partners help the oil and gas industry by providing miles of pipeline that transports everything from gasoline to heating oil, in addition to offering bulk storage for a large variety of petroleum products.

Pipelines and storage
Buckeye recently spent about $225 million to buy terminals and almost 1,000 miles of additional pipeline in North America, as part of its strategy to expand geographically. It also just raised its dividend by 5.3%, marking its 27th consecutive quarterly increase.

Enterprise recently signed a deal with Anadarko Petroleum to provide midstream services in the Eagle Ford shale area, expanding what was already a strategic objective for the company. The company has some of the most seasoned management in the industry and an extremely integrated midstream system. It's also well-positioned for growth in both established non-conventional shale plays like Eagle Ford, and emerging plays such as Mancos, Avalon, and Bone Spring.

Marine transportation
Teekay LNG provides marine transportation for liquefied natural gas and crude oil. It has roughly 21 LNG carriers, five LPG carriers, and 11 conventional crude oil tankers, including those still in the building stage. The company should see potential growth from new orders, most significantly in Australia. There is the potential demand for more than 100 new LNG carriers in the near future, and Teekay plans to be a major player in order to continue building its business. It also recently upped its distribution amount, and I wouldn't be surprised if it continued to do so, since earnings are expected to increase by 13% this year.

The Foolish bottom line
Any of the three companies listed above would be excellent additions to your dividend portfolio, especially if you're focusing on high-yielding companies that are somewhat shielded from the typical gyrations of the volatile commodity market. If you're interested in other great dividend-paying stocks, check out our new free report, "13 High Yielding Stocks You Can Buy Today." You'll be sure to find other home run companies to cash in on during this expensive market!

Jordan DiPietro owns no shares. Enterprise Products Partners is a Motley Fool Income Investor recommendation. The Fool owns shares of JPMorgan Chase and Limited Brands. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (14) | Recommend This Article (69)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 15, 2011, at 5:37 PM, anacostia wrote:

    I would note that master limited partnerships like these issue k-1 tax forms that can be considerably more complicated to deal with than 1099s from regular stocks and funds. For small investors in MLPs, this could outweigh the benefits of an MLP gain, either through your own headaches or extra tax preparation costs paid to a professional. Furthermore, the tax benefits that make MLPs attractive are lost if you hold the MLP in a tax-sheltered account like an IRA.

  • Report this Comment On April 15, 2011, at 5:40 PM, smace1 wrote:

    Some big problems with pipeline partnerships are the multible tax issuses. I own one, you recieve a K-1 from them and you can owe taxes in every state that the pipeline goes thourgh as well as foreign taxes. Luckily I did not own a big enough stake to have to pay the different state and Canadian tax.

  • Report this Comment On April 15, 2011, at 5:45 PM, straehle wrote:

    There are two caveats to understand when investing in limited partnership equities.

    First: These are not "qualified" dividends. They may be either ordinary dividends or return of capital. If the former, they are not taxed at the preferential 15% max rate, but at the taxpayer's normal tax rate, which may be higher. If treated as return of capital, they will not be taxed immediately, but as capital gains when the shares are sold. In either case, the yield stated may not be comparable to the yield of a regular equity after taxes.

    Second, since these are limited partnerships you will receive a form K-1 from the partnership and may be notified that you need to file a tax return in any state in which the partnership does business.

    These stocks do provide a larger apparent cash yield than most other stocks, but they come with there own set of complications.

  • Report this Comment On April 15, 2011, at 5:50 PM, xetn wrote:

    "Financial stocks, forced to slash their payments during the crash of 2008, have come roaring back. JPMorgan (NYSE: JPM ) has quintupled its quarterly dividend and announced a $15 billion buyback plan. Similarly, US Bancorp (NYSE: USB ) boosted its dividend by 150% and announced a 50 million-share buyback program."

    I wonder how much of these dividends are due to the bailouts. I am sure with out the bailouts, they might not even exist now. Just musing.

  • Report this Comment On April 15, 2011, at 10:34 PM, namedotname wrote:

    My K-1 for the 2010 tax year for KKR (another energy LLC) was ridiculous. I am paying more dollars in taxes than I actually received in distribution dollars.

    I know I know: basis. My accountant says that this increases my basis. But I have since sold it and everything I have gained still does not make up for the tax hit.

    Furthermore, it costs a lot of accountant time to track all the new number on yoru tax return with one of these K corps.

    I think some partners are more equal than others!

    Do the brokerage company's flag these as partnerships (warning warning warning) and not simple share of stock?

    I did not realize this was a partnership when I bought it.

    Will try to avoid in the future.

  • Report this Comment On April 15, 2011, at 11:13 PM, hardnokgrad wrote:

    Re MLPs,run 'master limited partnerships' thru GOOGLE and one of the useful links is www.naptp.org, a trade association of MLPs, which has a list of MLPs and tax tip info. I bought some for my IRA account,found out by accident on a webinar that MLP distributions (total) over $1000 in an IRA are taxable, called unrelated business income. My broker was clueless, (Don't expect them to flag ANYTHING for you,we're all big boys now-Remember ENRON?) so naptp.org was a gem. Hopefully before clicking 'placeorder' learn how to research the quote sheet better for things like debt ratio,payout ratio, earnings growth, etc. so you can grab those high dividends successfully instead of avoiding the investments. Good Luck!

  • Report this Comment On April 15, 2011, at 11:21 PM, hardnokgrad wrote:

    PS on MLPs The IRS pubs I found on trying to CALCULATE the tax are horrendously obique (they SUCK),so since i have about 3 years to reach $1k payout I can sell out if I cant figure it out by then. Has anybody been thru this already that can give me a thumbnail sketch on tax calculation?

  • Report this Comment On April 16, 2011, at 8:19 AM, namedotname wrote:

    My K-1 for the 2010 tax year for KKR (another energy LLC) was ridiculous. I am paying more dollars in taxes than I actually received in distribution dollars.

    I know I know: basis. My accountant says that this increases my basis. But I have since sold it and everything I have gained still does not make up for the tax hit.

    Furthermore, it costs a lot of accountant time to track all the new number on yoru tax return with one of these K corps.

    I think some partners are more equal than others!

    Do the brokerage company's flag these as partnerships (warning warning warning) and not simple share of stock?

    I did not realize this was a partnership when I bought it.

    Will try to avoid in the future.

  • Report this Comment On April 16, 2011, at 12:17 PM, vaidybala wrote:

    Does anyone comment about a US Form that Canadians should fill to get the 15% with hold tax on US dividends?

    Thanks

    Vaidy Bala at vaidy.bala@yahoo.ca

  • Report this Comment On April 18, 2011, at 2:01 PM, Schwaggz wrote:

    I think there are also "clawback" laws for MLP distributions, meaning that if the partnership get sued in the future, they can come after your distributions you recieved in the past.

    And yes, the taxes are incredibly difficult to do, to the point that i will not purchase one again.

  • Report this Comment On April 18, 2011, at 3:15 PM, blearynet wrote:

    Stay away from the MLPs. Nightmare tax complications that take a huge amount of time to work through. Been there, done that, not doing it again!

  • Report this Comment On April 19, 2011, at 1:47 AM, snapperreef wrote:

    It is a sad commentary on the USA that good investments must be bypassed because of a predatory and confiscatory tax system.

    We wonder why people are not investing in the US.

    For me the answer is that I'm afraid of what the tax system will do to my investment and what will it cost me to fill out the necessary tax forms.

    I appreciate the previous comments. They have convinced me not to buy a MLP.

  • Report this Comment On April 22, 2011, at 11:12 AM, docwife wrote:

    Since the tax situation is so difficult, why not buy the Alerian MLP Index ETN?

  • Report this Comment On May 12, 2011, at 12:19 PM, ikkyu2 wrote:

    For crying out loud, yet another in a long stream of articles that praises dividends, and then recommends stocks that pay no dividends.

    If you get the idea that the Fool authors don't know the difference between a dividend, an MLP taxable distribution, a royalty payment, and an REIT end-of-year cashflow mandatory distribution - you'd be right.

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