The recent launches of several MLP exchange traded products, as well as strong outperfomance, has increased investor awareness about MLPs as an asset class. With many investors hopping on the trend for extra dividend yields, I was wondering how MLPs were standing with regard to valuation and what returns could be expected over the next several years.
Since MLP's structure requires that they pay out a large portion of earnings as dividends, the dividend yield is probably the best measure of valuations. The dividend yield on the Alerian MLP index currently stands at 6.31% compared to a historical average 7.85% putting MLPs at nearly 20% overvalued relative to their average level. Below is a chart of the historical Alerian MLP index dividend yield.
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Expected returns of MLPs can be roughly calculated as Dividend Growth+Dividend Yield+Change in Valuation. So to calculate the expected annualized return over the next 5 years, I added the historical dividend growth rate (6.26%), the current yield (6.31%), and the annualized return from a reversion to the average valuation (-4.36%), ending up with an expected return of 8.21%. While this is a little less than half of the historical rate of return, this is still higher than what can be expected from many other asset classes (more on this in the future on my blog).
It should be noted that the historical data used is only about 15 years of data. It is quite possible that the dividend growth rate of over 6% will not continue in the future. It is also possible that widespread awareness of MLPs will push valuations higher and keep the dividend yield permanently lower.
Also, keep in mind that MLPs have certain tax implications. If you are unfamiliar with the MLP structure, make sure you research them before considering buying them.
Disclosure: No positions