Blending Speculative and Traditional Income Stocks

by: George Fisher

Income investments are usually acquired for the long term. Over time, building a section of one’s portfolio with selections purchased for speculative income could be a strategy employed by investors to increase cash income. Searching out controversial, not well known, or turn-around stock opportunities that offer higher yields can be rewarding both for cash income and for capital gains potential. However, with the higher yields usually comes with a higher risk to capital.

A great method of building a speculative income portfolio is to dedicate a portion of realized capital gains to higher yield investments. “Nibbling in”, or dollar cost averaging, an income stock is a proven method of building a respectable position over time.

Stock dividend re-investment (DRIP) should be an integral part of an income portfolio, unless there are immediate needs for the cash distribution. The investment growth potential of reinvesting an increasing dividend can’t be understated. Most brokerage houses offer DRIPs, along with company-sponsored plans. In addition, nibbling when stock prices are relatively cheap adds to the cash yields over time.

While there are added tax implications to Master Limited Partnerships (MLPs), their corporate structure is designed to generate cash distributions. REITs are also structured to generate shareholder cash returns. Both should be strongly considered in an income stock portfolio.

There are two methods of tracking cash distribution returns – Current Yield and Yield on Invested Capital. Current yield is an appropriate method to evaluate new stock or current position additions. Yield on invested capital is useful in determining overall past performance and to compare with other income opportunities.

For example, in 2004, an investor started a position in Enterprise Partners (NYSE:EPD), a large natural gas midstream MLP, and added sporadically to the position over the years. While the current yield is 6.0%, the yield on invested capital could be 7.3%, due to unit holder distribution increases and to purchasing shares at lower prices. When considering trading out of EPD, one factor could be replacing the present cash yield on invested capital.

Having a mixture of lower risk, lower yielding, traditional income stocks with higher risk, higher yielding selections can increase the overall blended cash return. Granted, the portfolio’s investment risk increases and this higher exposure should be offset by higher expected returns, both in distributions and in capital gains.

Listed below are seven stocks that offer above average yields. Some are higher risk and some are not followed by Wall Street. Included are the current yield, yield on capital, and the date the position was first initiated:

  • Dorchester Minerals (NASDAQ:DMLP) – Small-cap MLP that thinks it’s a natural gas royalty income trust. Current yield 6.4%, March 08, yield on capital 7.8%.
  • Enterprise Partners (EPD) – Midstream natural gas MLP. Current yield 6.0%, March 04, yield on capital 7.3%.
  • Algonquin Power (AQUNF.PK) – Canadian alternative energy generation utility. Current yield 5.5%, Sept 09, yield on capital 6.8%.
  • American Electric Power (NYSE:AEP) – Large Midwest-based electric utility. Current yield 4.7%, June 09, yield on capital 5.8%.
  • Gas Natural (NYSEMKT:EGAS) – Small-cap natural gas utility growing with a roll-up business model. Current yield 5.1%, Jan 08, yield on capital 6.3%.
  • Rayonier (NYSE:RYN) – Timber REIT with performance fiber exposure. Current yield 4.2%, Oct 07, yield on capital 5.9%.
  • Pope Resources (NASDAQ:POPE) – Small-cap timber MLP. Current yield 3.7%, April 04, yield on capital 4.8%.

Based on a blending of these positions, the current yield is 5.6% and the yield on invested capital is 6.8%. Over the next few years, distributions from most are expected to increase, adding to income, to capital gains potential, and to the yield on invested capital. These positions have also generated a combined unrealized capital gain of 21.8%.

In addition to stocks that offer higher current yield, there are turn-around companies that may have little or no shareholder distributions but which historically paid a dividend. Poor short-term operating results, start-ups, and corporate restructurings are usual candidates. It is anticipated that these companies will return to their distribution policies of the past. If so, both portfolio cash income and share prices should gain.

Examples could include:

  • Weyerhaeuser (NYSE:WY) - Large timber and building materials company converting to a REIT.
  • Terra Nova (NYSEARCA:TTT) – Small-cap start-up iron ore royalty firm.
  • Macquarie Infrastructure Co LLC (NYSE:MIC) – Highly leveraged with assets including private airport services, bulk liquid storage, and two utilities.
  • TimberWest – Canadian timber company with stapled units of notes and common.

It is important for investors to analyze the potential risks involved in any higher yielding stock, as there is usually a good reason for it. Based on an investor’s risk profile, speculative income opportunities could blend with more traditional income plays to create added cash returns.

As always, investors should conduct their own due diligence, should develop their own understanding of these potential opportunities, and should determine how it may fit their current financial situation.

Disclosure: Author owns shares of all companies listed