One of the great tax deductions available to the average American is the IRA deduction. Each year, we can transfer a few thousand dollars into a traditional IRA, which reduces our taxable income and, therefore, our income tax burden. However, unlike most other tax deductions, we don't have to complete this move by the end of last year; instead, we have until April 15 to move the money into our IRAs.
For those taking advantage of this face, there are almost unlimited options as what to do with that cash. However, with energy stocks beaten down so badly over the past year, it might make sense to park some of that money into one of these beaten-down names in hopes of earning a strong return during a future rebound.
With that in mind, we've come up with a list of three of our favorite energy stocks best owned in an IRA.
Matt DiLallo: Kinder Morgan (NYSE:KMI) is really the perfect energy stock for an IRA. First of all, unlike most other energy stocks, its direct exposure to volatile commodity prices is muted by the fact that 94% of its revenue is locked in by long-term contracts or commodity price hedges. That's why its stock has been largely unaffected by the recent downturn in commodity prices. That security makes it a great buy-to-hold stock for investors looking to build wealth for retirement.
In addition to this security, Kinder Morgan also has very visible growth. The company has a backlog of future projects that currently stand at $17.6 billion. Over 90% of those projects are backed by long-term, fee-based contracts, which will provide very stable cash flow growth in the years ahead.
Finally, because of the security of its cash flow, Kinder Morgan pays an above-average 4.3% dividend that's better kept in a tax-deferred account. That's because investors in the upper tax brackets would need to pay 15%-20% in taxes on those dividends if Kinder Morgan's shares were held in a taxable account. There's no reason to hand over such a large chunk of dividend income to Uncle Sam when investors have the option of holding on to it by owning the stock in an IRA, and reinvesting those dividends to further compound wealth.
Add it all up, and Kinder Morgan is the type of core energy stock an investor would want to anchor an IRA.
Bob Ciura: LinnCo (UNKNOWN:LNCO.DL) is my pick for a great energy stock to hold in an IRA. LinnCo is the financial holding entity of Linn Energy (NASDAQOTH:LINEQ). I believe Linn is a great company to own in an IRA because of its extremely high yield, and LinnCo does its investors even better.
First, LinnCo is not structured as an MLP, meaning shareholders won't have to deal with the hassles of a K-1 statement come tax time. Second, while LinnCo and Linn Energy offer the same $1.25 per-unit annualized distribution, LinnCo trades at a significant discount to Linn Energy. For example, at their respective April 1 closing prices, Linn Energy yielded 11%, while LinnCo offered a 12.5% yield.
As far as the business, it's no secret that Linn has had a rough year. As an upstream exploration and production company, Linn is extremely dependent on supportive commodity prices to stay afloat. Not surprisingly, the steep collapse in oil and gas prices over the past year has had a dramatic impact and caused Linn to cut its distribution by more than 50%.
Fortunately, if oil can manage to find a bottom, Linn could recover. Linn recently secured a much-needed $1 billion cash injection from private equity firm Quantum Energy. And, the company's 2015 distributions should be covered. Linn will slash capital spending this year by 29%. As a result, its 2015 capital budget of $520 million, along with its $417 million in distributions, should be covered by underlying cash flow.
If oil has indeed found a bottom, Linn's huge yield is perfect for an IRA, which is why I own LinnCo in my own IRA.
Jason Hall: Phillips 66 (NYSE:PSX) is actually one of the companies I own in my retirement account and have plans to buy more of soon. Sure; it might seem like a bad time, considering the stock has shot up 31% since mid-January already, but that's a short-term approach that ignores the company's stellar potential.
Unlike many other oil and gas-related companies, Phillips 66 is much less affected by falling commodity prices. Its refining margins remain strong, and like many U.S. refiners, it benefits from access to cheaper domestic crude, which means better margins on its refined products. Furthermore, its petrochemicals business is very well positioned for massive growth in global demand for plastics, polymers, and other goods that are made from the chemicals it produces, while the quickly growing midstream business should add major cash flows for decades to come, as the company invests heavily in new pipelines to connect new oil and gas fields to pipelines.
Furthermore, from a valuation perspective, the stock trades at a 30% discount to its trailing price to earnings ratio from as recently as September. At less than 10, this represents a good value for a company with solid long-term prospects, relatively minimal exposure to commodity prices, and a solid plan to grow its dividend and per-share earnings for years to come.
Bob Ciura owns shares of Kinder Morgan and Linn Co, LLC. Jason Hall owns shares of Phillips 66. Matt DiLallo owns shares of Linn Co, LLC, Linn Energy, LLC, and Phillips 66 and has the following options: short January 2016 $32.5 puts on Kinder Morgan and long January 2016 $32.5 calls on Kinder Morgan. The Motley Fool recommends Kinder Morgan. The Motley Fool owns shares of Kinder Morgan.
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