In Search Of Income Alternatives

3/3/2014


On this page last week, we presented our favorite five dividend stocks. Today we look beyond stocks, helping readers looking to enhance their income with master limited partnerships (MLPs) and real estate investment trusts (REITs).

Both MLPs and REITs trade on exchanges like stocks, but they are different from common stocks. You can learn more about REITs and MLPs below.

REITs and MLPs have substantially outperformed the S&P 500 Index since the end of 1995. The Alerian MLP Index has delivered a total return of 1,473% during that period, compared to 530% for the MSCI U.S. REIT Index and 297% for the S&P 500 Index. REITs and MLPs tend to pay higher yields than the average stock, and income accounts for much of the specialty indexes' returns.

A TALE OF 3 INDEXES
Alerian
MLP
Index
MSCI
U.S.
REIT
Index
S&P 500
Index
Dividend yield (%)
5.8
4.0
2.0
Value of $1,000 invested
at end of 1995 ($)
15,728
6,303
3,973
Annualized since June 2005
Price change (%)
7.2
2.0
5.2
Total return (%)
14.8
7.2
7.4
Sources: Alerian, Morgan Stanley.

We won't try to guess whether REITs and MLPs will continue to outperform, but income-oriented investors should check out the features below, as well as our Alternative Income Watch List at www.DowTheory.com/Go/Alt.

The ABCs of REITs

Real estate investment trusts (REITs) produce steady income and offer diversification benefits relative to bonds and common stocks, making them attractive to income-minded investors. But investors drawn solely to a REIT's elephantine yield should be aware of potential drawbacks.

At a glance, REITs seem like the best of all worlds. They provide exposure to the real-estate market while leaving the hassle of managing the property to someone else. These publicly traded trust units (akin to shares) provide investors with a stake in a portfolio of real estate or mortgages. REITs offer superior liquidity and diversification compared to direct ownership of the underlying assets. Not to mention the time and expense required to buy real property.

REITs are not highly correlated to stocks and bonds, meaning they can help diversify a stock-and-bond portfolio. REITs also serve as a hedge against inflation, since property value and rents usually rise during inflationary periods.

REITs can avoid corporate taxes by returning at least 90% of net income to unit holders. This practice produces fat yields. However, with limited retained earnings, REITs seeking to redevelop existing properties or purchase new ones often borrow heavily and/or issue new trust units to fund expansion. REITs' corporate-tax treatment complicates matters for investors at tax time. Not all REIT payouts are qualified, meaning investors may have to pay taxes at their ordinary-income rate. In addition, a portion of the cash flows REITs distribute to investors may represent a return of capital, which can lower the cost basis of the trusts.

Most REITs involve rental properties, and the contractual nature of these investments generates a steady stream of cash flows. However, the natural volatility that comes with trading on a public exchange means that a REIT's market valuation can vary widely from the value of its underlying properties. Their low reinvestment rate can cause REITs to underperform in periods when the market favors fast-growing companies.

As a group, REITs don't look particularly attractive now. The median REIT in our Watch List earns a Quadrix Overall score of 40 and Value score of 32, below the industry averages of 45 and 46, respectively, since mid-1999.

REAL ESTATE INVESTMENT TRUSTS
Below we present seven REITs rated A (above average) and 12 rated B (average). The group median at the bottom includes all 33 of the REITs on our Alternative Income Watch List.
Market
Value
($Bil.)
Div.
Yield
(%)
3-Yr.
Annual.
Div.
Growth
(%)
Total
--- Return ---
Price/Oper.
--- Cash Flow ---
12-Month
--- Growth ---
Est. EPS
--- Growth ---
Quadrix
---- Scores ----
Company (Price; Ticker)
3
Mos.
(%)
6
Mos.
(%)
Trailing
Trailing
Over
5-Yr. Median
Sales
(%)
EPS
(%)
Next
12
Mos.
(%)
Next
5 Yrs.
(%)
Value
Overall
Rank
American Tower
($80; AMT)
32.0
1.4
NA
3
15
20
0.97
17
(11)
(24)
18
22
52
B
Avalonbay Commun.
($129; AVB)
16.7
3.6
5
11
5
26
1.00
46
(49)
(71)
11
29
42
B
Boston Properties
($112; BXP) (u)
17.1
2.3
9
15
12
23
0.98
16
(14)
(12)
8
27
59
B
Camden Property Trust
($66; CPT)
5.8
4.0
22
16
6
15
0.88
12
17
18
7
32
24
B
Corrections America
($33; CXW) (d)
3.9
5.8
NA
1
3
11
1.20
(2)
24
2
7
66
45
B
Digital Realty Trust
($54; DLR) (u)
6.9
6.2
17
17
0
11
0.71
16
1
6
6
48
71
A
Equity Lifestyle
($40; ELS)
3.7
2.5
8
13
13
15
1.17
7
115
(19)
5
37
75
A
Extra Space Storage
($48; EXR)
5.5
3.3
54
16
18
21
1.16
28
39
16
13
32
73
A
Federal Realty Invst.
Trust ($111; FRT)
7.4
2.8
4
8
14
23
1.08
5
(2)
(19)
7
29
29
B
General Growth Pptys.
($22; GGP) (u)
21.5
2.5
36
8
18
24
1.10
2
NA
10
16
18
35
B
HCP ($37; HCP) (u)
17.1
5.8
4
2
(6)
15
0.75
12
11
(1)
3
62
62
A
Home Properties
($58; HME)
3.3
5.0
6
13
2
11
0.94
6
79
(10)
4
32
32
B
Host Hotels & Resorts
($20; HST)
14.8
2.7
141
7
16
14
0.91
1
NA
(47)
11
27
39
B
Kimco Realty ($22; KIM)
9.0
4.1
9
6
11
15
0.96
15
74
23
4
26
47
B
Omega Healthcare
($32; OHI)
3.9
6.1
11
0
14
14
1.08
19
13
(9)
3
54
62
A
Public Storage
($168; PSA)
29.0
3.3
19
11
11
21
1.19
8
28
(8)
6
32
70
A
Rayonier ($47; RYN)
6.0
4.2
11
7
(15)
11
0.89
13
6
22
1
57
57
A
Simon Property Group
($159; SPG)
49.5
3.1
21
7
11
19
1.04
7
(10)
(15)
7
33
41
B
Weyerhaeuser
($30; WY) (d)
17.6
2.9
(69)
1
11
18
0.66
21
73
(14)
5
45
41
B
Group median
8.5
4.0
8
8
11
16
1.07
12
7
9
6
32
40
(u) Rank upgrade.   (d) Rank downgrade.   Note: Quadrix scores are percentile ranks, with 100 the best.   NA Not available.


Master the partnership

We would like to tell you that master limited partnerships (MLPs) will duplicate the great returns they've managed in recent years; the Alerian MLP Index posted annualized total returns of 15.3% over the last 10 years. But such runs are not common, and investors shouldn't expect a repeat.

As a group, MLPs don't look particularly appealing. The median MLP on our watch lists earns an Overall score of 45. And because the traditional operating metrics don't matter as much in this area, we're less confident in the Quadrix scores. However, we do calculate 12-Factor and Reranked Overall scores that compare MLPs only to other MLPs.

Credit part of the outperformance to the popularity of dividend stocks (the Alerian MLP Index's yield has averaged 6.9% over the last decade) and part to the outperformance of energy stocks (the S&P 1500 Energy Sector Index has returned 250% over the last 10 years; no other sector topped 160%). About 80% of MLPs operate energy businesses, and more than half of the MLPs in our Quadrix universe own pipeline and storage companies.

Before you buy MLPs, here's what you should know:

• If MLPs derive 90% of their cash flows from "qualifying sources" such as natural resources, commodities, real estate, and some types of chemicals, they don't pay income taxes. This allows for high dividend yields.

• MLPs' tax advantages complicate the taxes of investors, who each year will receive a K-1 form showing how to treat the previous year's income.

• While all publicly traded partnerships tend to be lumped together as MLPs, some are technically limited liability companies (LLCs). The entities differ in some ways but are treated the same for tax purposes.

• Traditional operating statistics such as earnings don't mean much with MLPs. Analysts prefer to look at distributable cash flow (DCF). To calculate DCF we subtract interest expense and capital spending from earnings before interest, taxes, depreciation, and amortization (EBITDA).

MASTER LIMITED PARTNERSHIPS
Below we present nine master limited partnerships rated A (above average) and 13 rated B (average). The group median at the bottom includes all 35 of the MLPs on our Alternative Income Watch List. Distributable cash flow is a metric analysts use to measure the profits of MLPs. For our purposes, it represents earnings before interest, taxes, depreciation, and amortization (EBITDA) minus capital spending and interest expense.
Market
Value
($Bil.)
Div.
Yield
(%)
3-Yr.
Annual.
Div.
Growth
(%)
Distributable
--- Cash Flow ---
Market Value/
Distributable
--- Cash Flow ---
Enterprise Ratio
------ Quadrix Scores ------
Company (Price; Ticker)
In
Millions
($)
Growth,
Last 3
Years
(Ann.)
(%)
Trailing
Trailing
Over
5-Yr.
Median
Trailing
Trailing
Over
5-Yr.
Median
Overall
12-Factor
Sector
Reranked
Overall
Rank
Access Midstream
($58; ACMP)
10.3
3.8
108
(566)
NA
NA
NA
21.1
NA
75
52
55
B
Alliance Holding
($61; AHGP)
3.7
5.4
18
266
15
13.7
0.65
6.3
1.04
98
99
99
A
Alliance Resource
($83; ARLP) (u)
3.1
5.7
13
307
20
10.1
0.55
5.4
1.04
98
97
100
A
AmeriGas Partners
($43; APU) (u)
4.0
7.9
6
350
30
11.4
0.75
10.3
0.91
63
95
81
A
Blackstone Group
($32; BX)
19.6
4.1
25
1,765
NA
11.1
NA
15.0
NA
96
92
91
A
Buckeye Partners
($72; BPL) (u)
8.2
6.0
3
129
(13)
63.9
2.45
18.5
1.35
46
74
50
B
Cedar Fair
($54; FUN) (u)
3.0
5.2
118
202
15
14.8
1.68
10.5
1.41
77
96
75
A
DCP Midstream
($49; DPM)

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