Looking For High-Yield Alternatives?

10/9/2017


Even now, after eight years of artificially low interest rates and 20 years when the average S&P 1500 Index stock yielded 1.4%, many investors still expect yields of 3% or more from their stock portfolios.

On average, stocks in the S&P 1500 Index yield 1.6%, not much lower than the 1.8% yield at the end of 1994, as far back as our data goes. Yields have ebbed and flowed over the years, which makes sense because stock prices are much more volatile than dividend payments. However, even the highest average yields we've seen since 1994 are small compared to those from earlier generations. The last two decades' relatively low yields are just the latest stage in a much longer trend.

Seventy years ago, when most investors expected dividends to account for a large share of their stock returns, the S&P 500 Index as a whole yielded 5.6%, according to research by Professor Robert Shiller of Yale University. As recently as 1982, 35 years ago, the index yielded 4.9%. Those high-yielding days are probably gone forever.

Of the index's 10 sectors with data back to 1994, seven average lower yields today than they did 23 years ago.

What does all this mean?

It's not practical to expect a diversified portfolio of common stocks to provide a yield above 3% — the average stock in the utility sector, known for its high payouts, yields 3.1%. And if you stick to just utilities and a few high-yielders in other sectors, you'll probably end up with a lopsided portfolio far riskier than you seek.

Recent years have seen a surge in dividends and broadening in the number of payers, pushing up average yields. Yet despite those gains, yields still haven't returned to where they were in 1994, because stock prices have also surged. So, rather than insisting on a 3% to 4% yield, you'd be better off looking at the total-return prospect of your stocks.

If you really want yield, consider a small exposure to master limited partnerships (MLPs) and real estate investment trusts (REITs) as a way to boost your portfolio's income generation. We had income-hungry investors in mind when we created the Alternative Income Watch List (www.DowTheory.com/Go/Alt). The list features 46 REITS and 40 MLPs.

While REITs and MLPs trade like stocks, they are not traditional equities, and their specialized tax treatments support the payment of fatter dividends than most can manage. In addition, both asset classes use specialized metrics (funds from operations for REITs and distributable cash flow for MLPs) to report performance, making traditional profit-driven statistical analysis somewhat less effective.

In the following paragraphs, we present some pros and cons of REITs and MLPs. But before we get to the review, here's a general caveat:

Even the top-rated companies in the Alternative Income Watch List rarely qualify for any of our buy lists. These investments come with their own special risks and are not suitable for everyone. We advise subscribers interested in REITs and MLPs to purchase only those with A (above average) ratings, buy at least three different ones to avoid overconcentration, and limit these investments to no more than 10% or 15% of the equity portion of your portfolio.

Next up, five facts everyone should know before buying REITs or MLPs.

The properties of a REIT

1) Most REITs buy, sell, and manage real estate. As such, some of their profits may come from gains on the sale of property. This business model can lead to unusual tax issues, as some of the distributions may qualify as returns of capital. Some, but not all, REIT dividends are taxed at the ordinary-income rate, rather than the qualified dividend rate of 20% or less.

2) REITs offer some diversification benefits for portfolios of traditional stocks, though that benefit has eroded in recent years.

3) REITs trade not in shares, but in trust units. If these companies pay out 90% of their income to unitholders, they are exempt from corporate income taxes. Not surprisingly, most take advantage of this tax loophole and pay large dividends. The REITs on our Alternative Income Watch List average yields of 4.2%.

4) As a group, REITs score poorly in Quadrix. Those on our Alternative Income Watch List average Overall scores of 42, hurt by a 44 in Momentum and 39 in Value.

5) Just nine of the 46 REITs we cover earn A ratings, and none has what it takes to make our recommended lists.

OUR A-RATED REITs
---- 12-Month Growth ----
---- Valuation Ratios ----
-----------------------Quadrix Scores * -----------------------
Company
(Price; Ticker)
Div.
($)
Yield
(%)
Sales
(%)
Per-
Share
Profits
(%)
Operating
Cash Flow
(%)
Price/
Sales
Price/
Earnings
Price/
CFO
Momen-
tum
Value
Quality
Overall
12-
Factor
Sector
Reranked
Overall
American Tower
($139; AMT)
2.64
1.9
21
39
17
9.3
52
20.5
91
35
90
69
76
52
CoreCivic
($26; CXW)
1.68
6.5
0
3
(13)
1.7
15
9.2
26
78
45
51
82
57
Equity Lifestyle
Pptys. ($86; ELS)
1.95
2.3
6
11
15
8.8
42
20.8
58
26
84
55
75
81
Extra Space
Storage ($80; EXR)
3.12
3.9
19
26
39
9.3
30
18.0
86
46
91
83
94
90
LaSalle Hotel
Pptys. ($29; LHO)
1.80
6.2
(5)
135
(5)
2.8
26
9.9
40
80
82
85
95
92
National Retail
Pptys. ($42; NNN)
1.90
4.5
11
5
23
10.9
28
14.0
73
45
54
62
71
91
Omega Healthcare
($32; OHI)
2.56
8.1
9
12
8
7.1
17
10.9
36
78
72
74
81
88
RLJ Lodging Trust
($22; RLJ)
1.32
6.0
(3)
16
(11)
2.4
20
8.8
20
86
74
81
82
96
Weingarten Realty
($32; WRI)
1.54
4.8
8
(20)
8
6.9
34
15.8
62
41
65
54
78
76
REIT average **
4.2
5
17
9
7.5
37
17.0
44
39
61
42
61
46
* Quadrix scores are percentile ranks, with 100 the best. We've created special 12-Factor and Reranked Overall scores that compare REITs not to the broad financial sector, but to other REITs.      ** While all the REITs listed above earn A (above average) ratings, the average reflects all 46 of the REITs on our Alternative Income Watch List, which includes those rated B (average) and C (below average).

The energy of MLPs

1) MLPs trade as partnership units, not stocks. About three of every four MLPs operate in the energy sector, mostly midstream businesses such as pipelines and storage.

2) MLP unitholders are typically limited partners. Corporate decisions are made by general partners, who don't necessarily have the limited partners' best interests in mind.

3) In order to qualify for MLP status, companies must generate 90% of their cash flows from "qualifying sources," which usually means business models revolving around natural resources or chemicals. However, some financial companies have been organized as MLPs. MLPs are exempt from corporate income taxes.

4) Even more than with REITs, owning MLPs can complicate an investor's tax reporting. MLPs issue K-1 forms that break down how to record income. These forms can make filing your taxes a headache, as different portions of your distribution might require different tax treatments. In some cases, investors who hold MLPs in tax-deferred accounts may still end up liable for income taxes. Lastly, K-1 forms tend to arrive several weeks after other types of investment-related paperwork. If you buy MLPs, consider having a professional do your taxes.

5) On average, MLPs yield 7.8% and earn Quadrix Overall scores of 57, helped by a 67 in Value. While they look better than REITs on a fundamental basis, we still award just 13 of the 40 we cover a ranking of A. One MLP, EQT Midstream Partners ($76; EQM), is on the Long-Term Buy List. Another one, Star Gas Partners ($11; SGU), makes our Top 15 Utilities list, where you'll also find EQT Midstream.

OUR A-RATED MLPs
---- 12-Month Growth ----
---- Valuation Ratios ----
-----------------------Quadrix Scores * -----------------------
Company
(Price; Ticker)
Div.
($)
Yield
(%)
Sales
(%)
Per-
Share
Profits
(%)
Operating
Cash Flow
(%)
Price/
Sales
Price/
Earnings
Price/
CFO
Momen-
tum
Value
Quality
Overall
12-
Factor
Sector
Reranked
Overall
AllianceBernstein
($25; AB)
1.96
8.0
10
15
7
10.1
12
12.3
65
82
72
87
82
84
Alliance Holdings
($27; AHGP)
2.92
10.8
(1)
58
33
0.9
8
2.1
80
99
58
97
97
100
Andeavor Logistics
($49; ANDX)
3.88
7.9
25
(18)
17
3.6
24
9.5
NA
NA
NA
NA
NA
NA
Alliance Resource
($19; ARLP)
2.00
10.6
(1)
248
33
0.7
5
1.8
54
100
65
87
96
95
Boardwalk Pipeline
($15; BWP)
0.40
2.6
6
7
NA
2.7
11
NM
41
98
37
64
51
75
Blackstone Group
($34; BX)
2.16
6.4
114
500
NA
6.2
13
NM
70
70
73
76
63
71
EQT Midstream Part.
($76; EQM)
3.74
4.9
16
3
NA
7.7
15
NM
53
89
96
95
75
98
Energy Transfer
Equity ($17; ETE)
1.14
6.5
20
39
1
0.5
9
5.7
56
90
82
89
93
94
KKR ($20; KKR)
0.68
3.3
246
NA
NA
1.6
8
NM
87
89
54
92
87
89
Oaktree Capital
Group ($47; OAK)
5.24
11.1
138
220
NA
1.7
11
NM
95
89
81
96
99
99
Phillips 66 Partners
($53; PSXP)
2.46
4.6
(8)
18
99
7.1
22
9.6
56
67
92
84
73
79
Tallgrass Energy
Part. ($48; TEP)
3.70
7.7
6
15
NA
5.7
21
NM
49
83
85
89
67
91
Valero Energy
Partners ($45; VLP)
1.82
4.1
34
16
43
7.1
17
11.3
56
78
98
81
92
92
MLP average **
7.8
18
(3)
3
3.1
20
9.4
49
67
56
57
56
54
* Quadrix scores are percentile ranks, with 100 the best. We've created special 12-Factor and Reranked Overall scores that compare MLPs not to their market sectors such as energy or materials, but to other MLPs.     ** While all the MLPs listed above earn A (above average) ratings, the average reflects all 40 of the MLPs on our Alternative Income Watch List, which includes those rated B (average) and C (below average).     NA Not Available because of negative cash flow, or because of a lack of historical data in the wake of Tesoro's name change to Andeavor.     NM Not meaningful.     

Alternative analysis

Because REITs and MLPs rely on some statistics not tracked by the average stock, we must analyze them differently. To help us in this task, we created special REIT- and MLP-specific scores modeled on our 12-Factor and Reranked Overall scores. Like the 12-Factor and Reranked scores, our REIT and MLP scores rank the companies relative only to their peers.

Pickings can be slim, but we tend to prefer REITs and MLPs that score well in Overall, as well as the other two scores. Remember, even REITs and MLPs with high scores have a way of following their own path, not always moving with the broad market.


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