Energy stocks to power your portfolio

By Jon Markman

With gasoline and electricity prices soaring across the country, it's time for consumers to fight back with the most awesome weapon they've got.

No, not a sledgehammer for your local gas pump or walking shoes for your commute, or even a solar-power generator for your margarita blender.

It's your investment portfolio, my friends. The theme of this idea is that if you can't beat 'em, join 'em. There's a way for you to pour money from your tank right back into your bank account.

With timely, substantial stakes in a relatively new class of energy stocks that pay big, safe dividends, you can make enough steady income to pay for all your gasoline needs and then some. One nice thing is that this class of stocks is not very volatile, as it reacts little to change in the broad market or energy prices.

The formal name of this group of stocks is "master limited partnerships," or MLPs, but now that I've got all of those syllables out of the way I'll try not to repeat them. MLPs don't have any relation to energy partnerships that were sold on the private market years ago as passive tax shelters, and you are really not partnering in business with anyone.

MLPs are a group of securities that you can buy and sell just like normal stocks but with one big difference: By law, most of them provide a quarterly dividend, or cash payment, that is enormous relative to their price. (Another difference, while minor, needs to be noted as well: They have some tax-related eccentricities that may give your accountant a headache when you sell.)

Fill 'er up

How high are MLPs' dividend yields? Very, very high compared with most stocks and quite high even compared with most utilities. The average dividend yield of the 100 largest S&P 500 Index ($INX) stocks is 1.8%, and the average dividend yield of the 15 stocks in the Dow Jones Utilities Index ($UTIL) is 2.9%. Yet the average yield of the 50 leading MLPs is a whopping 6%, and many pay 7% or more.

If you don't know much about dividends because you've been a growth-stock investor all your life, here's some math to help you understand why they're so cool. It's like a pre-algebra word problem:

• According to government statistics, the average person drives 12,200 miles a year in a vehicle that gets 21 miles to the gallon.
• According to energy industry statistics, the average price of a gallon of gasoline nationwide over the past year was $2.50.
• Divide 12,200 by 21, and you'll see the average person uses about 580 gallons of gas annually. Multiply that by $2.50, and you'll see the average person spends about $1,450 per year for gasoline.
• So how much money do you need to put into an investment that yields 6% per year to get $1,450 in annual income? I'll spare you the rest of the equations, but the answer is about $24,000.

If you put about $24,000 of your investment portfolio into a set of MLPs, in other words, they'll throw off enough income to pay for an entire year's worth of gasoline.

Though that's pretty awesome by itself, where it really gets interesting is that MLPs have done a great job of providing capital appreciation as well. In fact, since 2000, an index that tracks these securities, called the Alerian MLP Index ($AMZ.X), is up 240%. One of the largest companies in the group, Enterprise Products Partners (EPD, news, msgs), is up 330% over that span, while another company, MarkWest Hydrocarbon (MWP, news, msgs), is up more than 1,100%.

I probably don't need to remind that you that the S&P 500 is down 2% over that period, while the Nasdaq-100 Index ($NDX.X) is down 50%.

A boost from a tax-law change

MLPs are an invention of mid-1980s federal tax policy designed to encourage investment in "midstream" energy assets. The companies in the sectors are primarily involved in the gathering, transportation and storage of crude oil, natural gas, coal and refined products, such as fuel oil and natural-gas liquids. They own the pipelines, storage tanks, terminals and tankers that move energy from the place where it is sucked out of the earth to the places where it is processed and used.

For their first 15 years, MLPs got little publicity and were bought primarily for their income by high-net-worth individuals on the recommendation of savvy financial advisers. They were not bought by institutions, mutual funds or foreigners because of a quirk in the way their distributions are taxed. They therefore got little research coverage at brokerages and traded in low volume.

A late-'90s change in tax law increased their attractiveness to institutions, and subsequent changes in their corporate structure have started to attract an array of individuals. The latest catalyst for increased interest is investors' waning interest in real estate investment trusts, or REITs, which now pay relatively low dividend yields, are tarred by the crisis in residential mortgages and have advanced to the point where they are pretty expensive on a valuation basis.

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