Playing The Yield Field

10/11/2010


Investors in common stocks may pay a steep opportunity cost for fleeing to the safety of 10-year Treasury notes, now paying a miserly 2.4% yield.

Low money-market and bond yields are encouraging income investors to explore other pastures. And while the Forecasts favors common stocks with decent yields and strong dividend-growth potential, we occasionally write about preferred stocks, master limited partnerships (MLPs), and royalty trusts. These asset classes are very different from traditional common stocks, and not only because they often pay yields of more than 5%.

Consider the securities listed in the table below. Most trade near their highs, and although investors have probably missed the bulk of the rally, they can still find good yields. Here are a few other things to consider about each investment vehicle before going after the income:

MLPs

MLPs collect cash flows from tangible assets, such as real estate or energy pipelines. MLPs are run by general partners, who typically own a small stake in the entity. Limited partners buy units — rather than shares — that trade on stock exchanges.

Three main factors contribute to MLPs’ high yields.

First, MLPs are required to distribute 90% of their earnings to unitholders.

Second, tax laws allow the entities to keep more of what they bring in. Many MLPs generate their income from depreciating assets, rendering it exempt from federal taxation, leaving more to distribute.

Third, general partners often have financial incentives to raise the dividend payout for limited partners.

In the past year, a surge of new money has rushed into this corner of the market without a significant fundamental change to its growth outlook. Many MLPs appear fully valued.

Royalty trusts

Royalty trusts earn income from natural resources, including coal, oil, and natural gas — all assets that deplete over time. Royalty trusts are financing vehicles rather than operating companies, with no real management or physical operations. They collect royalties on resources developed by other companies. Some distribute dividends monthly, others quarterly. Fluctuations in commodity prices can cause dividend payments to vary from one period to the next.

In most cases, federal tax laws do not classify dividends funded from depreciating and depleting assets as income. As such, dividends do not incur an immediate tax hit, instead lowering investors’ cost basis in their shares of the trust. While the investor must eventually pay taxes on any capital gains, they are deferred until the sale of the shares. Investors must also pay income taxes for any states where the royalties are generated.

Preferred stocks

Preferred stocks are the middle child of the investment world, junior to bonds but senior to common stocks. If a company declares bankruptcy, bondholders are paid first out of the assets, then preferred stockholders, then common stockholders. Unlike dividends of common stock, preferred dividends are often cumulative. That means that in the event of a dividend suspension, preferred shareholders must receive payments in arrears before the common dividend is restored.

While preferreds trade on exchanges like common stocks, they generally behave more like bonds than stocks, with prices highly sensitive to the issuer’s creditworthiness. Financial companies account for almost 90% of the preferred-stock market.

Many preferred stocks carry a call provision that lets the issuer repurchase the stock any time after the call date. That repayment possibility presents reinvestment risk for investors. Companies are more likely to call preferred stock after interest rates decline, when investors could find it difficult to reinvest the proceeds at a similar rate.

Preferred stocks
The 25 select preferred stocks listed below all earn investment-grade rates from both Standard & Poor’s and Moody’s. Ten of the preferred stocks appear eligible for the 15% federal tax rate on dividends, although that tax rate will expire at the end of the year unless Congress extends it. All 25 stocks have call prices of $25.
Preferred Stock (Price; Ticker)
Div.
($)
Yield
(%)
52-Week
Price Range
($)
Call Date
Discount
Or Premium
To Call
(%)
Moody's
Rating/S&P
Rating
Eligible
For 15%
Tax Rate
Dividends
Paid
AEGON N.V., 7.25%
($25; AEF)
1.81
7.3
25.40
-
16.73
12/15/12
(1)
Baa1 / BBB
Yes  
Mar., Jun.,
Sep., Dec.
Barclays Bank, 8.125%
($26; BCS-D)
2.03
7.8
26.97
-
21.65
6/15/13
4
Baa2 / BBB+
Yes  
Mar., Jun.,
Sep., Dec.
BB&T Capital VII, 8.10%
($28; BBT-C)
2.03
7.3
27.92
-
24.05
11/1/14
11
A2 / BBB
No  
Feb., May.,
Aug., Nov.
Deutsche Bank III, 7.60%
($27; DTK)
1.90
7.1
26.85
-
18.00
2/20/18
7
Aa3 / BBB+
Yes  
Feb., May.,
Aug., Nov.
Duke Realty, 8.375% O
($26; DRE-O)
2.09
8.0
27.80
-
22.28
2/22/13
5
Baa3 / BBB-
No  
Mar., Jun.,
Sep., Dec.
HSBC Holdings, 8.00% B
($27; HCS-B)
2.00
7.4
27.30
-
25.30
12/15/15
9
A3 / A-
Yes  
Mar., Jun.,
Sep., Dec.
Interstate Pwr. & Light,
8.375% B ($29; IPL-B)
2.09
7.2
30.50
-
26.50
3/15/13
17
Baa2 / BBB-
Yes  
Mar., Jun.,
Sep., Dec.
J.P. Morgan Chase,
8.625% J ($28; JPM-I)
2.16
7.6
29.09
-
25.15
9/1/13
13
A2 / BBB+
Yes  
Mar., Jun.,
Sep., Dec.
J.P. Morgan Ch. XXIV,
6.875% X ($26; JPM-W)
1.72
6.6
26.50
-
21.55
8/1/12
4
A1 / BBB+
No  
Feb., May.,
Aug., Nov.
Kimco Realty, 7.75% G
($26; KIM-G)
1.94
7.6
27.02
-
21.70
10/10/12
3
Baa2 / BBB-
No  
Jan., Apr.,
Jul., Oct.
M&T Capital IV, 8.50%
($27; MTB-A)
2.13
7.9
28.46
-
24.85
1/31/13
7
Baa1 / BBB
No  
Mar., Jun.,
Sep., Dec.
Morgan Stanley Cap. VII,
6.60% ($25; MSZ)
1.65
6.7
25.06
-
19.59
10/15/11
(1)
A3 / BBB
No  
Jan., Apr.,
Jul., Oct.
Morgan Stanley Cap. VIII,
6.45% ($25; MSK)
1.61
6.5
25.00
-
19.11
7/15/12
0
A3 / BBB
No  
Jan., Apr.,
Jul., Oct.
National City Trust III,
6.625% ($25; NCC-B)
1.66
6.6
25.09
-
19.40
5/25/12
0
Baa1 / BBB
No  
Feb., May.,
Aug., Nov.
PNC Capital Trust E,
7.75% ($26; PNH)
1.94
7.5
27.07
-
23.01
3/15/13
4
Baa1 / BBB
No  
Mar., Jun.,
Sep., Dec.
Principal Financial,
6.518% B ($25; PFG-B)
1.63
6.5
28.75
-
18.02
6/30/15
1
Baa3 / BBB
Yes  
Mar., Jun.,
Sep., Dec.
Public Storage,
6.875% O ($26; PSA-O)
1.72
6.7
26.50
-
22.84
4/15/15
3
Baa1 / BBB
No  
Mar., Jun.,
Sep., Dec.
Public Storage,
7.00% N ($26; PSA-N)
1.75
6.8
26.15
-
22.39
7/2/12
3
Baa1 / BBB
No  
Mar., Jun.,
Sep., Dec.
RenaissanceRe,
6.60% D ($25; RNR-D)
1.65
6.6
25.00
-
19.15
12/1/11
0
Baa3 / BBB+
Yes  
Mar., Jun.,
Sep., Dec.
Santander Finance,
6.50% ($24; STD-C)
1.63
6.9
28.50
-
16.56
1/31/17
(5)
A2 / A-
Yes  
Jan., Apr.,
Jul., Oct.
Sovereign Cap. Trust V,
7.75% ($25; SOV-B)
1.94
7.6
25.97
-
20.91
5/22/11
1
Baa2 / BBB+
No  
Feb., May.,
Aug., Nov.
Torchmark Cap. Trust III,
7.10% ($25; TMK-A)
1.78
7.0
26.26
-
22.05
6/1/11
2
Baa2 / BBB+
No  
Mar., Jun.,
Sep., Dec.
U.S. Bancorp,
7.875% D ($27; USB-L)
1.97
7.2
29.79
-
25.00
4/15/13
10
A3 / BBB+
Yes  
Jan., Apr.,
Jul., Oct.
USB Capital XI, 6.60%
($25; USB-J)
1.65
6.6
27.50
-
21.00
9/15/11
0
A1 / BBB+
No  
Mar., Jun.,
Sep., Dec.
Wells Fargo Capital XI,
6.25% ($25; FWF)
1.56
6.1
25.50
-
20.67
6/15/12
2
Baa2 / A-
No  
Mar., Jun.,
Sep., Dec.
                           
Trusts and partnerships
The seven royalty trusts and eight master limited partnerships listed below earn Quadrix Overall scores of 60 or higher and sport attractive yields. Trusts and partnerships are not for everyone, as they carry risks and tax issues not typically associated with common stocks. Furthermore, unlike preferred stocks, the securities do not pay fixed dividends. Investors should limit exposure to trusts and partnerships to 10% of their portfolio.
– 3-Year Dividend History –
———— Quadrix Scores ————
Company (Price; Ticker)
52-Week
Range
($)
Est.
Div.
($)
Est.
Yield
(%)
2009
($)
2008
($)
2007
($)
Value
Quality
Fin'l
Str.
Overall
Dividends Paid
Royalty trusts
Baytex Energy ($37; BTE)
38
-
23
2.11
5.7
1.38
2.49
2.03
18
76
74
64
Monthly
BP Prudhoe Bay
($104; BPT)
106
-
75
8.38
8.1
6.01
11.71
8.21
21
87
100
77
Jan, Apr,
Jul, Oct
Cross Timbers
($36; CRT)
39
-
28
2.83
7.9
1.89
5.16
3.30
36
59
100
63
Monthly
Hugoton ($20; HGT)
22
-
15
1.60
7.9
0.73
2.91
1.73
40
55
100
73
Monthly
Mesabi ($39; MSB)
39
-
10
3.20
8.2
1.15
2.48
1.35
33
94
100
93
Feb, May,
Aug, Nov
Pengrowth Energy
($11; PGH)
12
-
4
0.81
7.3
1.03
2.51
2.72
77
28
83
70
Monthly
Permian Basin ($20; PBT)
20
-
12
1.35
6.8
0.81
2.39
1.45
24
71
100
70
Monthly
Master limited partnerships
Alliance Resource
($60; ARLP)
61
-
36
3.24
5.4
2.95
2.53
2.20
75
93
68
99
Feb, May,
Aug, Nov
Breitburn Energy
($19; BBEP)
19
-
10
1.53
8.2
0.52
1.99
1.67
67
31
72
64
Feb, May,
Aug, Nov
Cheniere Energy
($19; CQP)
20
-
9
1.70
8.8
1.70
1.70
0.88
45
99
78
91
Feb, May,
Aug, Nov
El Paso Pipeline
($32; EPB)
34
-
20
1.60
5.0
1.33
1.01
0.00
30
77
81
75
Feb, May,
Aug, Nov
KKR & Co. ($11; KKR)
11
-

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