Avi Morris'  Instablog

Stocks are having one of their best years in history, Gold isn't doing badly.  However, gold didn't suffer the large setbacks that many big stocks had in the last year.  Fundamentals for owning gold are changing in its favor.

In the past, gold has been a passive, defensive investment to be held in times of high inflation.  Now that the weak dollar is becoming more important in global investments, there is less interest by foreign governments in holding US dollars as part of foreign reserves.  Euros € and other foreign currencies (i.e. Japanese yen ¥) are being considered as alternatives.  In eastern Asia, where gold is more trusted as a storehouse of wealth, there is greater interest in holding gold as a reserve (currency).  Just 2 weeks ago India bought 2 tons in gold.  The balance of trade is going in the direction of eastern Asia suggesting growing new demand for gold.

Investing in gold has been made much easier for individuals with a wider array of investment products.  My website features ways to learn more about gold investment products.  A simple way using stock skills is to buy gold's ETF, GLD.  Its shares can be purchased like any other stock.  Hassles associated with buying commodity and future contracts are eliminated.  When gold goes up (or down), the ETF will track gold commodity price changes.

In the old days, some advisers would recommend that good diversification should include 5-10% invested in gold.  In a new world of investments, when the federal government is running massive deficits with large growing Treasury debt, gold may have more appeal for a portion of investment portfolios.
       
Disclosure: No positions

MLPs are completing a record year of gains.  The previous record year for the Alerian MLP Index was 2003 when the index gained 35% and the comparable index with reinvested income was up almost 45%.  This year the index began at a depressed 176 and the index including reinvested income was at 428.  Each achieved a record gain by July 2009, when the index reached 238 and the index with reinvested income hit 619.  Subsequent gains are making 2009 the best year in the 14 year history of the Alerian MLP Index.

Both indices were started on the last day of 1995 & the long term track records are among the best for any industry group during this period.  The compounded annual growth rate for the MLP Index has been 7%, the index including reinvested income has had an astounding 16% growth rate. Even with high volatility in the last year, MLPs are still known for their low beta (i.e. volatility).

For those interested in participating in MLP growth by investing with a basket of companies, a new ETF is available.  It's called JPMorgan (the manager) with an NYSE symbol - AMJ.  It tracks the Alerian MLP Index (AMZ), valued at 10% of the index.  Dividends are paid from net investment income.  Tax hassle associated with owning limited partnerships is eliminated by owning shares in this ETF.  For those who want to own individual company units, more than 50 MLPs are listed.  Most transport oil, gas or coal.  Average yields are near 8% and income is largely tax free (at least in the current year). 

Disclosure: No positions

Procter & Gamble (PG), a Dow stock, is a 170 year old manufacturer of some of the most famous brands in the US.  Typically the brands are #1 in their businesses and include: Head & Shoulders, Olay, Braun, Gillette, Crest, Oral-B, Dawn, Duracell, Tide, Bounty, Charmin, Pampers, etc.  P&G has increased annual dividends for more than 50 years.  This quality business has an excellent track record of growth for dividends & stock prices.  However, when markets had started their descent at the start of this decade, P&G plunged from 120 to the 50s, a house of bricks caved in on their business model.  Since then they have rebounded and the stock price is above its highs one decade ago (adjusted for a 2-1 stock split).  P&G has felt the effects of this recession with a decline in EPS for FY2009 (ending June 30) and another small earnings decline is estimated for next year.  EPS should be $4.00 in FY2010 which will easily cover the $1.32 dividend along with a modest increase next year (to keep their track record of annual dividend increases intact).

Becton Dickinson, BDX, is a medical technology company manufacturing medical supplies, devices, laboratory equipment, and diagnostic products worldwide for over 110 years. They have an excellent track record of growing dividends and the stock has risen accordingly.  10 years ago the stock was under 10 and rose to 90.  But the current recession hurt the stock, causing it to sink to 60.  The stock held up well during the market sell-off by trading sideways in the 60s.  Now it's 73 with a yield of almost 2% from the $1.32 dividend.  EPS is expected to increase 2% to over $5.00 in 2009 and another increase of 10% is expected next year.
 
Legget Platt (LEG), founded in 1883, is another Dividend Aristocrat which has had a very tough time in the recession.  They have 4 divisions, including one selling parts to car companies and another selling residential furnishings.  Earnings have been hit so hard they don't cover the dividend.  In Q4 of 2007 (just prior to the recession), LEG raised the quarterly dividend from 18¢ to 25¢.  In Q3, 2009, they upped the rate by a penny even though they are not earning this rate.  However, it will be sufficient to keep them in the group assuming the rate is maintained through 2010.  EPS for 2009 is forecasted at 75¢ and is expected to increase to only $1.06 next year.  Their dividend is at risk.  Masco (MAS), former Dividend Aristocrat, cut theirs early this year when earnings did not support the dividend.  The stock is just under $20 and the 5+% yield tells the story, with high yield comes risk.  Very venturesome investors might be interested in the high yield but many other investors will pass.

Dividend Aristocrats are an excellent source of ideas for very smart investment. However each one needs to be investigated before investing.

Disclosure: no positions

High yield sectors have had a truly outstanding year in 2009.  Junk (high yield) bond funds are up over 50%, from a time when their yields were at record levels (above 25%).  Then risk was being punished, risk averse became the driving force for investors.  The subsequent rally has reduced yields from dividends paid by junk bond funds to 10-12%, not too far above the 9% area they have yielded in the best of times.  Last week, Bill Gross, head of PIMCO, the world's largest owner of debt, said junk bonds had peaked.  Junk bond funds sold off but have bounced back partially this week.

The Dow Jones REIT Index plunged from the 250s prior to the financial crisis last year to 82 early this year.  When the financial crisis hit full force, some REITs were forced to cut or eliminate dividends under financial pressure, including the largest REIT - Simon Property (SPG).  Then REITs had a strong recovery around midyear.  After more than doubling from their lows, REIT gains have been limited by choppy trading in the last 3 months.  The index has waffled around 160 or 10% below its peak 6 weeks ago.  Worries grow that vacancy rates on properties will rise if economic recovery is slow. 

MLPs suffered a similar decline.  The Alerian MLP Index had already fallen to 270 by September of last year, then it plunged below 155 (a 6 year low) in the extreme market sell-off.  Early this year, the yield on the index soared to over 15% (never seen before).  Since then MLPs rallied, many have doubled from depressed levels.  Their businesses continue strong, moving more oil and gas through pipelines.  MLPs have not had trouble selling more equity units and borrowing more money.  Raising capital is critical for their their investment programs, pipelines and terminals.  They have just announced Q3 earnings and distributions for Q4.  Many of their distributions showed quarter over quarter distribution increases.

While near their yearly highs, high yield securities are feeling selling pressures after their best year in history.  Their future is tied to a rapidly improving economy.  Greater concerns about a sluggish rebound are encouraging successful investors to take some money off the table.  A faster recovery will solve many problems associated with high yield securities.  Stretching out the recovery will aggravate problems - higher default rates on junk bonds, higher vacancy rates on properties, etc. I worry that high unemployment rates (including under-employed workers) and soggy levels for housing, autos & retail sales into 2010 will bring higher yields and correspondingly lower prices for these securities.

Disclosure: long SPG

Dividends and capital gains are the 2 ways for earning money when investing in stocks.  With stocks experiencing one of their best years in history, dividends are being ignored even though they can be helpful earning a steady rate of return.  The S&P 500 Dividend Aristocrats are members of the group required to have a minimum track record of 25 consecutive years of paying higher annual dividends.  Only about 10% qualify.  Below are 2 excellent companies, one which everybody knows & a second which is not as well known.  Each has an outstanding and consistent record of dividend growth, a valuable tool in earning high rates of return.

Coca Cola (KO), founded in 1886, has the best known brand names in the world.   They sell Coca Cola and related cola syrups to their bottlers which are in turn sold to retail businesses around the world.  Coca Cola claims to be in more countries than the UN.  Additional drinks include Minute Maid, A&W Root Beer, Glaceau, Dasani and brands specific to foreign countries.  In the last 2 decades, the stock had a run from 20 to over 80 in the middle of the first decade.  Then it pulled back to the 40s where it has largely traded since then.  In the last 10 years sales doubled to $32 billion, EPS and dividends have more than doubled.  Their finances are quite strong, allowing them to purchase more than 1.2 billion shares of treasury stock. Coca Cola has increased the annual dividends for more than 40 consecutive years.  At 53, Coca Cola still yields over 3% (far above yields on short term instruments).  With aggressive expansion overseas, i.e. China, Russia, etc., revenues and profits should keep growing so they can continue their streak of higher annual dividends.

Automatic Data Processing (ADP) does not have a well known brand name, but it has an outstanding track record of growth.  They were founded 60 years ago to provide business services (many are payroll related) and this has been a growth business.  In the prior decade the stock went from 6 into the 40s as markets reached record highs in 2000.  Even though the current decade has been a tough time for the stock, earnings per share have doubled (aided by treasury stock purchases) while the stock has mostly traded in the 40s.  Increasing the yearly dividends raised the yield from 1% to over 3%.  A month ago, in the annual report, their president talked about the strength of their business models and said, "I remain optimistic about out longer-term objective to achieve high single-digit annual organic revenue growth, supplemented by acquisitions, with at least 15% earnings per share growth."  He also mentioned that ADP is one of a handful of companies with AAA credit ratings.  At 41, the stock yields a respectable 3.3% which should continue to increase going forward.

Dividend Aristocrats are high quality companies (like these).  They have outstanding track records, especially when measured by consistent growth of dividends, as rewarding investments over the long run.  With a yield of 2-3% (or more), earning an annual rate of return of 10% becomes easier.  Steady annual dividend increases helped with reinvested dividends provide even more help.  One word of caution.  There are a number of Dividend Aristocrat lists posted and by definition they have to be at least 1 year old.  I estimate about 10 companies have been removed from the list in the last 2 years.  When evaluating any company, it is important to verify that dividends have been increased particularly in the last 2 years (a time when quite a few have not continued their streak of higher annual dividends).  Gains from dividends deserve more respect.

Disclosure:  Long K

MLPs keep roaring ahead taking them to new yearly highs.  It seems like we're in a new world when remembering last October.  I had just written a primer article on MLPs, introducing many investors to a new type of investment.  That was at the start of September, after MLPs had already fallen 20% from their peaks in the prior year (along with other market averages).  Then they plunged and by October it looked liked they were heading for zero.  Risk averse was the driving force in investment thinking, all securities with high yields were being thrown away without regard to their investment value.  The collapse of Lehman in September made matters worse for MLPs because they had been a big believer (and investor) in MLPs.  MLPs went through an awful 6 months as yields shot up to over 15%.  But believers were rewarded.

From their lows, MLPs have rebounded sharply.  The Alerian MLP Index (AMZ) at 265, is up a dazzling 100+ points from the lows in March.  Aside from a modest setback in June and settling into a trading range during August-September, the rise has been about as steady as could be hoped for.  In October, the index is up 10% from the low of the latest trading range. 

The reasons for this optimism are simple.  MLPs have gotten through the credit crisis in excellent shape.  They continued to sell units to boost equity, allowing more borrowings to finance expansion of pipelines and terminals (long term assets).  Kinder Morgan (KMP) is the largest MLP.  They've raised over $750 million in 2009 (75% of their goal for 2009) by selling units which allowed them to increase borrowings.  Last month Enterprise Products Partners (EPD) sold $250 million in units and arranged to borrow an additional $1.1 billion.  In addition, a merger with TEPPCO Partners (TPP) was just approved by TEPPCO unit holders at a special meeting.  This will create the country's largest MLP with a value of approximately $30 billion.  Other MLPs are buying additional assets (terminals, etc.), those transactions are part of their large capital expansion programs.  These stories are common among MLPs, they have been able to finance expansion during the credit crisis.

OK, it has not all been smooth.  A couple of smaller MLPs, such as Constellation Energy (CEP) and Breitburn Energy Partners (BBEP), have had to eliminate distributions so they could concentrate on reducing debt.  But they are making progress and their units have more than doubled from the 2009 lows.  Quarterly updates will be released next week.

For those new to MLPs, a little extra explanation may be helpful.  Investors buy units (not shares) in master limited partnerships (MLP).  MLPs pay distributions which are typically 80-90% tax free and their yields are high.  But tax free brings tax hassle.  A yearly K-1 tax statement is sent around early March with terms like depletion and amortization that have to be dealt with.  However I've been told that tax preparation programs help with tax preparation.  In addition, records have to be kept since the cost basis of the investment is reduced. 

Risk premium, the spread of the yield on the Alerian MLP index over the yield on the 10-year Treasury bond, is very important.  The rule of thumb had been that a 200 basis point spread was to be expected.  A narrowed spread indicated a good time to sell.  MLPs peaked in July 2007 with a spread near zero when the yield on the Treasury bond had risen to 5¼%.  That was the time to sell.  A few months ago the premium shot up to well over 1000 basis points, signaling a good time to buy MLPs at low prices.  The yield on the Alerian MLP Index is currently 7.8%, down sharply from 15% earlier this year, with a spread of more than 400 basis points.  Bulls would say this spread still gives a buy signal (based on the 200 point basis point standard).  Bears would say the risk is higher now, justifying a larger spread.

There are ways to invest in MLPs by buying stock.  A tracking new ETF (AMJ) is priced at 10% of the Alerian MLP Index value.  It rises and falls along with the Alerian Index and provides a dividend from net distribution income.  2 of the largest MLPs have stock equivalents in addition to their units:

Kinder Morgan (KMR)
Enbridge Energy (EEQ)

These are called management corporations, each share has one unit backing it and generally sells at a small discount to the unit value.  When distributions are paid, shareholders receive an equivalent stock dividend.  Being corporations, they are retirement account friendly and tax efficient for individual accounts since there is no need to issue a 1099 tax form.  The stock dividends make for a very efficient automatic dividend reinvestment program. 

The astounding rise this year comes from greater recognition that MLPs have gotten through the credit crisis without significant problems.  They have high yields which are largely tax-free, units have low beta price movements and their track record of growth is excellent at a time when shaggy long term track records are common.  The Alerian Index has grown 2.7 times in 15 years.  With reinvested income included, that index has grown 6.9 times.  MLPs are overbought short term, but a pullback by MLPs should provide a better time to invest for term growth and income.

Disclosure: no positions