Archive for November, 2008

Master Limited Partnerships

Wednesday, November 12th, 2008

I’ve been promising an overview of Master Limited Partnerships (MLPs) and here it is, for what it’s worth. Going into this I had little idea of how complicated MLPs are compared with ordinary dividend paying stocks. Sure, MLPs trade just like stocks, but their characteristics–especially when it comes to taxes–are vastly different. It would behoove you to at least be aware of them before you doing any investing in this area.

What is an MLP?
MLPs have exactly the same liquid trading characteristics as stocks, but they are very different from them. MLPs are structured as limited partnerships: the general partner is the company that runs the operations and the limited partners are the share holders, called unit holders, who share in the profits. (Note: An “L P” after a company name means limited partnership and is most likely an MLP, if in the energy space.) MLPs are what is known as “pass-through” entities, meaning that income generated from operations is not taxed on the corporate level. Rather, the entire dividend (called a distribution) is “passed-through” to the unit holders who are ultimately responsible for paying the taxes. But don’t let that dissuade you because in most cases asset depreciation can offset the majority (usually 80-90%) of the tax liability. Because the distribution is not doubly taxed allows for a higher distribution amount which is good for the unit holders.

Types of MLPs
Most MLPs are engaged in oil and gas businesses (including propane) involving distribution (via pipeline), storage, and retailing. There are a few MLPs involved in coal (which could be a hot commodity if President-elect Obama has his way), one involved in amusement parks (FUN). and another involved with cemeteries (STON)! Don’t laugh–the last one could have a bright future what with the aging of the baby boomers.

Tax consequences
MLPs maximize their tax advantages by owning long-term depreciating assets such as pipelines. Unit holders can offset their distributions by the rate of depreciation (also called the rate of deferral—typically on the order of 80-90%) and pay taxes on the remaining 10-20% at ordinary income tax rates. The balance of the tax isn’t owed until the security is sold or until the total distribution income exceeds the cost basis. This is why this investment is great for those with long investment horizons.

It’s also a good one for estate planning. If the owner of the security dies, the reduced cost basis is stepped up to the current share price thus eliminating any current tax liability.

MLPs that operate in more than one state (and most do) will have tax consequences in most of them. Each state has a certain specified threshold above which you’ll be required to pay taxes. This can be a real drag come tax time. My recommendation with all of the above is that unless you’re a tax-filing ace, have a professional tax preparer help you with MLPs.

MLPs in IRAs
Holding an MLP in an IRA is not unwise, but it is complicated. If you receive MLP distributions totaling more than $1000 in a year, you might be taxed on it (yes, even in an IRA!) depending on how much of that distribution can be considered to be unrelated business income (UBTI). You can find out the amount subject to UBTI by looking at your K-1 statements. On line 20: Other Information, UBTI is coded by the letter “V”. If you have more than one MLP, add up all of the UBTIs. (Note: The UBTI can be a negative number.) If the total is a positive number, you’ll owe taxes on that amount.

Why buy MLPs now?
MLPs are an attractive vehicle especially for those of you with longer investment horizons because of their relatively high distribution rate. Plus, you’re getting a steady double-digit (in most cases) rate of return which is nothing to sneer at. In a recent article, Jim Jubak feels that natural gas is the short-term winner from the utility cash crunch, saying that when the economy finally turns around demand for electricity will skyrocket forcing utilities to turn to natural gas as the only quick fix. He goes on to say that lowering interest rates will put upward pressure on high dividend paying stocks and MLPs which will be more attractive investments than low-paying treasury notes.

What to look for when shopping for an MLP
1. A high tax basis which is the level at which you can depreciate assets. You want this as high as possible, at least 80%. To keep this rate high, a company needs to either make new acquisitions or construct new pipelines or facilities. You can read about a company’s expansion plans in its quarterly and annual reports in the management summary as well is in the Summary section found in the SEC 10-Q and 10-K reports (www.sec.gov).

2. A company with a strong distribution growth history. Most, if not all, MLPs pay their distributions quarterly. One place to check their distribution growth pattern is at Yahoo! Finance. Just enter the stock symbol, click on Historical Prices, and select Dividends Only. It’s that easy.

3. Some MLPs offer tremendous incentives to its managers (e.g., the general partners) if they can meet certain distribution pay out levels. These incentives should be listed in the company’s annual report.

4. A large, established player in the field. High construction costs coupled with demanding government regulations makes entry into this field difficult. MLPs with large asset bases and widespread operations hold a definite advantage over the smaller players.

5. You also want to check the balance sheet to make sure that the company is not loaded up with short term debt.

MLP risks
The article cited below from Personal Investment Notes gave the best discussion of MLP risks:
“The pipeline MLPs are considered more conservative and are characterized by stable cash flow and slow growth. Propane distributors are more aggressive investments than pipelines. The propane industry is a non-regulated, seasonal, slow-growth industry with moderate exposure to commodity prices. Coal MLPs also have moderate exposure to commodity price volatility. However, their principal end-user customers are public utilities, thus, overall risk is considered relatively low. The riskiest are the E&P MLPs [oil and gas exploration and production].

Generally, the MLP distribution is not guaranteed. Most MLPs (like corporations) have restrictive debt covenants, which can impair distribution payments if a default occurs.”

Summary
There’s a lot here to know but I hope I haven’t dissuaded from adding a couple of these to your portfolio. After all, if they’re good enough for Jim Jubak, Jim Cramer, and Mark Cuban, they’re certainly worth a look.

Tomorrow, we’ll take a technical look at the MLP field and I’ll toss in my recommendations.

References
Master Limited Partnerships. Personal Investment Notes. 5/16/08
http://invest.smartlabsoftware.com/archives/7

Should you follow Buffett this time?, Jim Jubak on MSN MoneyCentral, 11/11/08.
http://articles.moneycentral.msn.com/Investing/JubaksJournal/should-you-follow-buffett-this-time.aspx

In Remembrance

Tuesday, November 11th, 2008

In honor of Veteran’s Day, the Stock Market Cookbook is taking the day off.

To all of the brave men and women who have risked life and limb defending the principles of freedom and democracy, a heart-felt “Thank You!” We shall not forget your service.

MANDA Holdings as of 11/10/08

Monday, November 10th, 2008

Click on image for larger view.

New MANDA Addition: Centennial Communications

Monday, November 10th, 2008

I know I said that I was putting a freeze on any new acquisitions for my M&A Fund, but rules are made to be broken and besides, this looks like a fairly solid deal. The credit crisis seems to be easing (a little) and consolidation in the cellular communications space is inevitable. Well, today Centennial Communications (CYCL), a guppy in the ocean of cellular carriers, was swallowed up by industry leviathan AT&T (T). It’s an all-cash deal worth $8.50 per share. Centennial’s stock more than doubled on the news over yesterday’s closing price of $3.84. Centennial’s largest shareholder has already agreed to the merger. Completion of the deal is subject to shareholder and regulatory approvals. AT&T figures the acquisition to be completed by the second quarter of 2009.

An analyst quoted by Reuters put in his two cent: “I’m surprised to see a deal in this economic climate. But on the other hand, AT&T is using cash on hand and taking advantage of the significant decline in asset prices,” said Michael Nelson, a wireless analyst at Stanford Group. “This is one of the few rural wireless assets left. Perhaps it was inevitable,” he added.

I bought the stock near the end of the day at $7.80, representing a 9% return on the trade (assuming the deal goes through). That’s roughly a 30% annualized return. I’ll take that right now, thank you!

Reader FYI: I’m doing research on those high dividend paying master limited partnerships (MLPs) and should have a report on them in the next few days, so stay tuned!

High Growth Rate Dividend Achievers

Friday, November 7th, 2008

Over this past week, we’ve been looking at picking up some reliable, high-dividend paying stocks. In Wednesday’s blog, I suggested looking at the components of the High Growth Rate Dividend Achievers, an index based on criteria set by Mergent’s Dividend Achievers. From this index of one hundred stocks, I selected three (plus one other not from this list) that had dividend yields (DY) greater than 4.5 and that I felt would have the most chance of success in this credit-starved market environment.

Here are my top picks:

Pfizer (PFE). Current price: $16.86, DY = 7.6%. Pfizer has been steadily declining since 2000 (down 65% ) and its current chart is not encouraging. Sure, the stock has been trading in an upward-sloping channel, but volume has been decreasing. This is a bearish sign, and judging from its previous decline, I expect the price to drop another $2 or so from this level. However, if President-elect Obama begins to spruce up the healthcare system, the drug stocks (and anything in the drug and healthcare sectors) could benefit. When (and if) the price does decline further and the stock looks like its on a rebound, you might want to sell an out of the money cash-secured put.

Polaris Industries (PII). Current price: $32.51, DY = 4.7%. Polaris makes snowmobiles and other all-terrain vehicles (ATVs). It beat last quarter’s estimates and raised full-year guidance, although fourth quarter profits are projected to be flat. Stock-wise, the company lost half its value in the last couple of months. It just broke major support at $36 and although it bounced off support at $25, that doesn’t mean it can’t go lower, especially if consumers feel that a new snowmobile is a budgetary extravagance. If the stock heads up, try selling the $30 puts. If it falls below $30, sell the $25 puts.

Kinder-Morgan Energy Partnership (KMP). Current price: $53.40, DY = 7.6%. KMP specializes in pipeline transport and energy storage of various materials including crude oil, natural gas, and coal. It operates as a Master Limited Partnership (MLP). Many analysts feel that MLPs are safe havens in this market and their low debts and high cash-flows are perfectly structured to weather the credit storm. Now is a great time to pick up these puppies. KMP has strong resistance at $55 and unless oil falls a lot further, I wouldn’t be too worried about picking up some shares right now.

Enterprise Products Partners (EPD). Current price: $24.50, DY = 8.5%. Although not on the Dividend Achiever list, EPD is another oil and gas MLP, similar to KMP above. Even its chart pattern is similar to KMP’s. Resistance is at $25, and I’d be a buyer of this one at this level. The reason that EPD probably didn’t make the index cut is that the company has only been around for 10 years. It has steadily increased dividends since 2000 with many annual increases greater than 10%.

More on MLPs
A week or two ago entrepreneur Mark Cuban said in a CNBC interview that he was buying up MLPs because of their relative stability and high dividends. He’s a billionaire and I’m not, and what he had to say made a lot of sense. I think a little hitchhiking around the MLP universe is in order which will hopefully turn up a few more high growth dividend achievers.

But I’ll leave that adventure for next week. Have a good weekend! Go Cal! Beat ‘SC!!!

Another Dividend Stock Screener

Thursday, November 6th, 2008

I forgot to mention another resource in yesterday’s recipe to find high dividend achiever stocks. MSN MoneyCentral’s stock screener is a very comprehensive and powerful tool that is free to use. (Click this link to go directly to it.)

In yesterday’s recipe I mentioned that using Mergent’s Dividend Achievers book and/or one of their premade indexes would help you identify good, undervalued stocks with currently high dividend yields. The theory is that you start buying these stocks (especially in your retirement account) while you can still lock in these high yields. Another way is to use the above screener as an identification tool.

The screener is a powerful tool with about as many inputs as an investor could want. Unfortunately though, it can’t access data any further back than five years unlike the Mergent book which includes relevant data for up to 50 years. Notwithstanding, one can still use the screener to find some good stocks.

Initializing your search
What you need to do is just play around with the input parameters. There are a lot of them, but don’t get discouraged. Once you get the hang of it, it’s really pretty easy. Here’s a few parameters you might want to use as your foundation screen:

Dividend Growth
This parameter is the one that should be on all of your screens. Companies with strong historical growth rates are usually committed to continuing it. You can vary the growth rate, but I like to start with a growth rate >= 10. If you don’t get many at this level, try lowering it.

  • Growth Rates: 5-year dividend growth >= 10

Current Dividend Yield
Since we’re looking for beaten down stocks to lock in a high dividend yield, we should set our parameter to choose those stocks with DY’s greater than our minimum acceptable level. Mine is 5.

  • Dividends: Current Dividend Yield >=5

EPS Growth Rate
Since dividends come from earnings, we want some sort of industry consensus that the company will be able to at least pay its dividend in the coming years. A 10% minimum average annual earnings growth over the next five years will weed out the shaky companies (think GM and many financial stocks).

  • Analyst Projections: EPS Growth Next 5 Yrs >=5

These are the basic parameters. Here are some you can use as a springboard to refine your search even further.

Refining your search
We’re looking for undervalued companies with steady cash flow. Parameters such as a low PEG (Price/Earnings ratio to Growth) will find undervalued stocks while those involving low debt/equity ratios will find companies who will stand a better chance of being able to service pay their dividend instead of servicing their debt.

  • Advisor FYI: Price Ratios: PEG Ratio Below 1 = True Now
  • Advisor FYI: Financial Condition: Debt to Equity Decreased = Since (Last year or last quarter)

Some evaluation of the condition of the company can be had by using the Analyst Projections: Mean Recommendation >= Hold. I know I’ve mentioned my skepticism when it comes to analysts, but if you think a company looks rosy but all of Wall Street is screaming “Sell!”, there just may be something wrong with it.

Simulation results
Using all of the above parameters (with Debt/Equity Decreased Since Last Quarter) yielded four stocks: Sasol LTD (SSL), New York Community Bancorp (NYB), CNOOC LTD (CEO), and Preferred Bank (PFBC). They all have DYs ranging from 5-8%, and all are heading downwards following the overall market. I prefer the first two because of their lower price (compared with CEO) and their higher liquidity (PFBC average daily volume is 86k).

A nifty way to get into either SSL or NYB would be to write cash-secured puts. I’d recommend the Nov 22.5 puts or the Nov 20 puts (more conservative) for SSL, and the Nov 12.5 put for NYB. Remember that selling put premium is tantamount to lowering your cost basis. (Cost basis = strike price – premium)

Summary
I do hope you try this screener or something like it. (I know Zack’s has one but I don’t think the free version offers as many features as the MSN screening tool.) Now’s a good time to make your holiday dividend paying shopping list. Hey, a good dividend paying stock would also make a lovely addition to a young relative’s tax-deferred college fund. (Check with your accountant first.)

Election Break: A quick lesson in chartology

Tuesday, November 4th, 2008

In the September 5th blog, we looked at how the 99 Cents Store’s stock (NDN) was on a roll. It was on the eve of a major price restructuring announcement and it was anyone’s guess how it would affect the stock. Apparently, shareholders seemed pleased with the news since the stock gapped up on heavy volume on the next trading day. Looking at this chart again this morning, I thought that it would make a ideal candidate for a lesson in basic chart reading.

What the daily chart tells us

[Click on the charts for a larger view.]

The daily chart above shows two horizontal lines, line A at $9 and line B at $11.20. You can see how line A provided support for the stock back last spring. It broke through that level on heavy volume on May 19th, and if you had been long the stock, that was your signal to either sell it of protect it with a put. Those with more risk tolerance might have shorted it then which would have paid off very well. The signal to cover your short position came on July 15th when a bottoming tail formed. If you weren’t convinced that a bottom was put in on that day, the large up bar the next day should have convinced you to exit.

From the bottoming tail, the stock continued to rise just as fast as it had fallen. It broke through minor resistance at $8 in mid-August where it spent a week or so consolidating before breaking through major resistance at $9 in September. From there, it continued upward where it hit a ceiling at $11.20. Unable to break through it, the stock retreated testing the $9 support level twice. Finally, it broke through the $11.20 ceiling last Thursday and is in the process of consolidating at this level. (Now would be a good time to pick it up if you’re interested.)

What the weekly chart tells us
So, the next question is: If we’re now long the stock, how much profit can we reasonably expect? The answer can be found by looking at the weekly chart below. The stock formed a double bottom in January and July. A general rule used by technicians is that when a double top (or bottom) is formed, the amount of expected profit is the difference between the center of the formation and the top (or bottom) value. (This is exactly the same calculation as in the head and shoulders formation.) On the chart, these values are $10 at the middle of the double bottom and $6 at the bottoms giving us a $4 estimation for profit. The profit is measured from the center value so that we can expect the stock to rise to $14. There is resistance at this level and if the stock can’t break through it, I would definitely exit the play.

Summary
I hope you were able to follow this example. I know it’s a piece of cake for all of you seasoned technicians but many people don’t understand the basics of chart reading and I’m here to help with that. I’d say that today looks like an excellent time to buy the stock, but I do have reservations about how the market might react should a democratic president and a democratic Congress be elected. You might wish to wait until tomorrow before making any market commitments. However, if you do buy at this level, I’d set a protective stop at $10.56 which was the low of the pre-breakout bar on October 29th.

Now back to my research on dividend stocks…

Dividend Stocks: Why you should own them!

Monday, November 3rd, 2008

For the past month or so, the financial media including dear ol’ moi has been harping on the virtues of snagging some good dividend stocks while the pickings are ripe. The market is still on shaky ground and if the presidential election and the G20 meeting don’t upset the applecart, chances are good we’ll see a rebound (especially if the VIX can break its support level at 52). This means that now is the time to make a shopping list of stocks that pay a healthy dividend.

But what comprises a “good” dividend stock and why should you buy them now?

The case for owning dividend paying stocks
Did you know that stock dividends accounted for 42% of stock market gains over the past 90 years? According to a study by Ned Davis Research, dividend paying stocks increased 10.2% per year since 1972 while non-dividend stocks increased a relatively measly 4.4%. Inflation alone was about 4%. Also, dividend stocks in general are about half as volatile as their non-dividend counterparts. This means that although they won’t rise as fast, they won’t fall as fast, either, providing you with a bit of a cushion in bear markets (See reference below for full details on why you should own dividend paying stocks.)

Timing is critical to dividend yields
You want to pick up good dividend paying stocks when their prices are low.
Why? Because your dividend yield is increased. Remember that the dividend yield is the annual dividend divided by the stock price, so a lower stock price will increase the yield (assuming the dividend remains the same). For example, if a $100 stock pays a quarterly dividend of 50 cents, the dividend yield is 2% (((4x$0.50)/$100)x100%). But if that same stock loses half of its value, the dividend yield doubles to 4%. This effect becomes much more pronounced with lower priced stocks. One important thing to note is that even if your stock rises in price, your yield is locked in since it’s tied to the purchase price.

Dividend reinvestment
Most (if not all) brokerage firms will let you specify if you’d like your dividends payed in cash or reinvested in the company stock. The answer to this depends on your age and circumstances. People at or near retirement may elect to take the cash while others might prefer the other option. If you’re still young enough and don’t need the income, I strongly advise reinvesting because it will not only increase your position size but the size of your dividend payout. The great thing about automatic dividend reinvestment is that there’s no commission fee on the transaction. And speaking of commission costs, many companies will let you purchase stock directly through their DRIP programs (Dividend Re-Investment Plan) at no extra cost. The downside is that you won’t have all of your holdings in one place which may not be worth the hassle especially if your commission fees are small.

Tax considerations
Dividends are taxed at the 15% rate which is lower than the capital gains rate (but that may not last depending on the outcome of tomorrow’s election). Buying dividend paying stocks makes good sense in a retirement account. Some investments such as dividends from REITS (real estate investment trusts) may not fall under this special tax rate. Check with your accountant for further details.

Summary
I hope you see the benefits of owning dividend stocks. In the next few days, I’ll be going through several recipes on how to find beaten down dividend payers and toss in my B O B (best of breed) recommendations from each group. This miniseries is sure to be worth your while.

Reference
Article: The secret to boosting portfolio performance by 42%, by Donald Moine, 2006. USA Asset Management.