In Peter Lynch's classic book One Up On Wall Street, he proclaims his love for a good business that Wall Street ignores. But today, Wall Street's actively ignoring an entire class of businesses -- giving you an opportunity for profit. What's so special about master limited partnerships, and why should dividend investors clamor in pursuit of them?
Master limited partnerships (MLPs) are a quirky and complex investment class: partnerships that trade like stocks and pass their income directly to shareholders. In order to qualify as an MLP, a firm must earn 90% of its income through activities or interest relating to natural resources, commodities, or real estate.
Instead of paying corporate income tax, MLPs pass the tax liability to investors. Oh sure, you're thinking, stick it to the little guy. But a portion of distributions are tax-deferred for as long as the investor holds shares. So it's possible to collect returns upward of 6% while deferring the income tax.
The usual suspects
Business models that hinge on huge, initial capital investments benefit from this structure. Many oil and gas pipeline businesses chose to structure this way; about 80% of MLPs operate in energy-related businesses.
Pipeline MLPs can draw income from many different states, so an investor with a portfolio of MLPs can end up having to fill out a bunch of extra tax forms (sorry, CPAs). And MLPs held in retirement accounts can produce something called "unrelated business taxable income": large amounts of which require investors to file additional tax returns.
In other words, MLPs have their complications. They're high maintenance but with appeal -- like the college boyfriend my mom warned me about.
A leg up on Wall Street
MLPs boast extremely low levels of institutional ownership. I love that because it means Wall Street hasn't caught on to MLPs yet. And Wall Street firms may never catch on thanks to one simple fact -- they can't invest in MLPs.
Pensions, endowments, and 401(k) plans are restricted from owning MLPs. And MLPs pose a pain in the neck for mutual funds thanks to their cumbersome tax reporting requirements.
The MVPs of MLPs
Let's take a look at three MLPs that come to mind. All toil in the "midstream" part of the energy business, which means they collect fees for transporting and storing oil and gas. As such, "midstream" businesses are considerably more stable than the exploring and refining sides of the energy business.
5-Year Average Dividend Yield
Enbridge Energy Partners
Energy Transfer Partners
Kinder Morgan Energy Partners
Sources: The Motley Fool and Yahoo! Finance.
Not only do these MLPs reward shareholders with terrific yields, their five-year average annual dividend yields hover between 5.7% and 8.7%; a testament to the consistency of the income they generate.
Remarkably, the combined market caps of these MLPs equal about 9% of the market cap of ExxonMobil
An unlikely colleague
Even though the majority of MLPs are pipeline businesses, not all are. Enter Stonemor Partners
Cemetery companies buy vast acres of land in which customers inevitably repose indefinitely. Real estate acquisitions represent a huge cost for cemetery businesses and, therefore, a strong case for a MLP structure. Stonemor Partners LP is the only publically traded cemetery structured as an MLP, and the company yields an otherworldly 9.5%. Morbid? Indeed. A good investment? Quite possibly.
Overlooked and underrated
Position your portfolio for income and tax relief by considering MLPs. While they're rife with challenges and require education on your part, they're worth the hassle, quite unlike the troublemaker college boyfriend.
If you find MLPs intriguing and want to learn more beyond the basics I've laid out here, read about MLPs here. If you don't feel like complicating your tax situation or you have an aversion to IRS forms, then learn about an exciting energy company that is not a MLP by reading about one energy stock with sensational prospects.