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The Strength Of Master Limited Partnerships

|Includes:ABT, BBEPQ, DUK, EPD, KMP, The Coca-Cola Company (KO), MMM, WPZ
Investors are prone to fret. And why not? We have the government playing chicken with the debt ceiling, the eurozone undergoing the considerable spasms of Greek debt and other traumas, so investors are looking for places to put their money where the action will be profits, not uncomfortable headlines. And while it's true that all investments carry risk, the relative risk of one investment compared to another is often telling.

You need not invest directly in, for example, Greece to be a party to its financial troubles. If you invest in global companies which do even slight business in Greece, even ones such as Coca-Cola (NYSE: KO), then that portion of your investment will be directly affected by what goes on. Now Coke is a great company, and no investor should panic, as Coke's business is truly global, but few would think of Coke in the context of Greece. Likewise, exposure to some of the Greek debt through US banks and more so to European banks, which are-or were-otherwise healthy, can occur. So investors can even have conservative investments or dividend stocks which can find themselves in less than attractive business situations.

Income And More

The above discussion isn't intended to frighten anyone out of conservative, stable stocks, many of which pay good dividends and have the chance at capital appreciation. But many income investors are still not aware, or don't fully appreciate, a class of stocks that pay excellent dividends, have low volatility, or beta, and feature some surprisingly strong companies. I'm talking again about master limited partnerships, or MLPs, of course. Most of these are in the oil and gas business, but they are not subject to the commodity price fluctuation of oil in the same way that other oil stocks are. As most are pipeline companies, they transport oil and gas and thus the fees collected constitute their revenue.

Attractions Of MLPs

Because of the legal structure of master limited partnerships, they are required to pass their earnings through to investors, much in the same way a REIT does. They also pay no corporate income tax. Their dividends, called distributions, come from the cash the business generates, and instead of the metric free cash flow, or FCF, that is useful for gauging most companies' ability to pay dividends, we can assess MLPs by calculating distributable cash flow, or DCF.

This is simple enough to do. It's a simple add back method from net income, where you add back depreciation, depletion, amortization and any other non-cash items, then subtract capital expenditures, and this gives you the total, distributable cash flow. It takes out the depreciation and amortization along with other accounting items that don't have anything to do with generating cash, and thus gives a true picture of the company's cash available either to fund projects or, importantly, pass on to you the investor via a distribution.

Stability Plus Yield

The ten-year Treasury yielded 2.9% as of this writing, while solid dividend stocks including industrial conglomerate 3M (NYSE: MMM) yielded 2.3%, Coca-Cola 2.8%, drug company Abbott Laboratories (NYSE: ABT) 3.6%, and utility Duke Energy (NYSE: DUK) 5.3%, all fairly respectable yields and more in today's low-interest climate. A sampling of MLPs in the oil and gas business shows Kinder Morgan Energy Partners LP (NYSE: KMP) yields 6.2%, Enterprise Products Partners (NYSE: EPD) yields 5.8%, William Partners, LP (NYSE: WPZ) 5.56%, and Breitburn Energy Partners, LP (Nasdaq: BBEP) yields 8.3%.

What About Volatility?

The markets have experienced their share of volatility this year, and there may be more on the horizon, so that's a fair question. No stock is immune from either risk or volatility, however, beta, the measure of a stock's volatility relative to the market, with the market's beta being a 1.0, can be instructive. A great, stable, steadily growing company which is one of the 30 Dow Industrial stocks, 3M, has a beta of 0.82, so it's on average less volatile than the stock market at large. Then look at one of the MLPs, Kinder Morgan Energy, which has a beta of 0.32.

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Capital Appreciation With MLPs

So the yields look good on MLPs, while their volatility tends to be surprisingly low given those yields and that they are in the oil and gas business. What about capital appreciation? Using again Kinder Morgan as an example, we can see its stock price has grown from around the $45 per share price five years ago to as high as $78 a share this year. Its business is stable, so investors have bid up shares nicely in recognition of this along with the strong dividend it consistently pays.

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Many MLPs To Choose From

There are many MLPs which share these kinds of characteristics and make for attractive components in a yield oriented portfolio, along with a mix of other dividend stocks of course.

Remember that unlike an ordinary corporation, Kinder Morgan and the MLPs cannot decide to forego or suspend dividend payments as another company might. You'll recall that even once steady payers such as the banks slashed or eliminated their dividends after the financial crisis of 2008-2009. There are tax implications for MLPs beyond the scope of this article. MLPs can have tax advantages because a portion of their payouts may be tax deferred, though a portion, usually small, may be designated as ordinary income and subject to tax. You should consult your CPA or tax professional on that, as always.

At our Dividend Genius newsletter, we can help you find MLPs that will pay off in profits to you as an investor. Overall, MLPs can be a great addition to any income investor's portfolio, as their stability and higher yields can furnish you with income and even some growth in these volatile times. Keep that in mind as you invest.

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