This Controversial Dividend Strategy Turned $10,000 Into $54,000

Includes: EPD
by: StreetAuthority

By Elliott Gue

Oftentimes, one investor's fear can be another investor's opportunity.

A panicked market sell-off can make a great buying opportunity for those with cash. Or one bad earnings report or negative press release can knock an otherwise good stock down to a bargain price - another great buying opportunity.

But there's one move a company can make that investors fear - and most don't consider it an opportunity. But I do.

I'm talking about secondary offerings.

While share buybacks are more popular, sometimes dividend-paying stocks need cash in order to keep growing and keep paying higher dividends. That's where a secondary offering comes in.

Let me explain...

As you already know, companies with a history of buying back stock can make great investments. Buying back shares boosts the value of the outstanding shares - the company has the same value and fewer shares, making its stock scarcer and more valuable.

Secondary offerings work the opposite way. Usually when a business needs to raise cash, it can issue new shares to the public - increasing the share count and causing existing shares to lose value. You can see why shareholders aren't always thrilled with secondary offerings.

But while secondary offerings are usually known to reduce share value, they're not always bad news. In fact, under certain circumstances, new share sales offer an outstanding buying opportunity.

That's because not all firms that sell additional shares are strapped for cash. Even better, under the right conditions, new share offerings can signal that a firm is about to significantly boost its dividends or distributions.

Consider the case of Enterprise Products Partners (NYSE: EPD), one of the largest owners and operators of oil and natural gas pipelines and other basic energy infrastructure in the United States.

In the past decade, Enterprise has completed a total of 16 secondary offerings, raising more than $5.3 billion in new capital.

Despite raising all that capital, the stock has been one of the true wealth-building powerhouses of the past decade.

If you'd invested $10,000 in Enterprise a decade ago and reinvested all of your distributions, you'd now have nearly $54,000 compared with just $22,000 for the S&P 500.

In fact, one of the best strategies for buying Enterprise over the years has been to add to your position whenever the company announces the sale of additional units. You can see what I mean in the table below.

Predictably, the immediate market reaction to Enterprise's 16 secondary offerings during the past decade has been negative - on average, the stock opened 2.2% lower the morning after the firm announced the sale of additional units. The knee-jerk selling comes after holders face unit value dilution.

But that's where the opportunity has been. After investors have time to digest news of the secondary offering, the reaction has been far more positive.

In the six months following a secondary unit offering, Enterprise Products Partners has rallied an average of 12%. And 12 months later, Enterprise has returned an average of more than 23%. That's far better than the stock's average annualized gain of 18.2% during the past decade.

So why has Enterprise performed so well after issuing so-called "value-crushing" secondary offerings?

Here's the key: When Enterprise Products Partners sells additional units, it typically uses the new money to fund an acquisition or new growth project, which will serve to pad the firm's cash available for distribution. In other words, while each unit may represent a smaller share of the Enterprise pie, the pie itself is growing more than enough to offset that dilution.

Few stocks have been as consistent in this regard as Enterprise - the MLP recently increased its quarterly payout for the 34th consecutive time. That's eight-and-a-half years of raising distributions every single quarter.

Its 66-cent quarterly distribution already gives it a 4.7% yield, but look for that to keep going up as Enterprise raises cash through more secondary offerings.

So, while many companies that buy back their own stock can receive popular support among shareholders, the right dividend-payers that have a history of secondary offerings - and subsequent dividend raises - can sometimes make for even better investments.

Original Post

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: StreetAuthority LLC owns shares of EPD in one or more of its “real money” portfolios.