3 Big Dividends From Investing's Best-Kept Secret

Master limited partnerships, or MLPs, are one of dividend investing's best-kept secrets. With yields sometimes reaching 5% to 7% or more, they offer some of the biggest, safest dividends around.

These big, sustainable yields come courtesy of Congress. To encourage development of America's energy infrastructure, Congress grants MLPs a complete exemption from taxes at the company level. As such, MLPs are essentially pass-through entities, transferring nearly all the cash they generate to their shareholders, or "unitholders" in MLP jargon. You, the unitholder, then pay taxes on the dividends, or "distributions," you receive.

In this first installment of an ongoing Motley Fool series, we look at three MLPs, see exactly what each is up to in its particular energy sector, and take a close look at the performance of each. By the end of today's column, you'll have a good feel of what to look for when evaluating an MLP and have three solid MLP investing ideas to get you started.

1. Enterprise Products Partners (NYS: EPD)
Enterprise Products Partners is the largest publicly traded energy partnership in North America, according to its website, with operations in the U.S., Canada, and the Gulf of Mexico. Its stated assets include "50,200 miles of natural gas, crude oil, and petrochemical pipelines; 192 million barrels of natural gas liquids, refined products, and crude oil storage capacity; and 27 billion cubic feet of natural-gas storage capacity."

The company was founded in 1986 and is based out of Houston. By the numbers:

  • A good yield by non-MLP standards is about 3% -- an arbitrary number, but one we feel separates the wheat from the chaff. With a distribution yield of 4.9%, Enterprise comes in comfortably higher than that.

  • Payout ratios are important because they give you a clue as to how sustainable a distribution is. Generally for non-MLPs, the higher the ratio, the less sustainable the distribution. Enterprise's current payout ratio is 101%, which is no problem because, as we said earlier, MLPs are designed to pay out as much money as possible to unitholders.

  • It's always nice to see an ever-increasing distribution, and Enterprise's has grown by a little more than 6% in each of the last three years. The five-year average dividend yield for the company is 6.8%.

Enterprise's P/E of 21 tells you the stock is trading a bit on the high side. But energy stocks are hot right now, and for good reason; the country is currently in something of a natural-gas boom. Any company that can move and store natural gas at the capacity of Enterprise Products Partners is bound to be trading for more than the average.

2. Alliance Resource Partners (NAS: ARLP)
Founded in 1971, Alliance Resource Partners was the coal industry's first publicly traded MLP. The Tulsa, Okla.-based company mines and markets coal in the U.S., operating 10 underground mining facilities in three primary regions: the Illinois Basin, central Appalachia, and northern Appalachia. At the end of 2011, Alliance had approximately 911.4 million tons of proven and probable coal reserves, and it's currently the fifth-largest coal producer in the Eastern U.S.

By the numbers:

  • Alliance pays a generous 5.9% distribution yield.

  • Alliance's payout ratio is 45% -- unusually low for an MLP, but it should make the distribution all the more sustainable in the end.

  • The company's five-year average dividend yield is 6.7%, with dividend growth over the last three years of almost 14% annually.

Alliance Resource Partners trades at an eminently reasonable P/E of 11. Coal still powers half of America's electrical grid and isn't going anywhere anytime soon. Alliance is an easy and personally profitable way to benefit from a power-hungry country like the U.S.

3. Linn Energy (NAS: LINE)
"Linn Energy's mission is to acquire, develop, and maximize cash flow from a growing portfolio of long-life oil and natural gas assets." So says the company's website, and to that end the company's assets have grown from a few natural gas wells to "interests in more than 9,000 producing wells across the U.S."

Linn operates in four primary areas in the U.S.: mid-continent, the Permian Basin, Michigan, and California. By the numbers:

  • Linn pays an astounding 7.3% yield and has paid a quarterly distribution ever since it went public in 2006.

  • The company's payout ratio is a big 108%.

  • The five-year average dividend yield is 9.9%.

The current P/E of 15 tells you Linn's shares are fairly priced. Linn hasn't been around for that long but has grown substantially and returned a lot of money to unitholders.

And the winner is...
There you are -- three high-yielding, sustainable dividend stocks, courtesy of your U.S. Congress, and one of income investing's best-kept secrets: master limited partnerships. And while I think all three are solid investments, I keep coming back to Linn Energy. First, it pays the highest dividend, and it has an average over five years of paying substantially more. The share price is very reasonable, so you can stock up on them, and the P/E is right at the industry average. On top of all that, the company is growing by leaps and bounds in an industry (natural gas) that's positively booming right now, so even though the company was only founded in 2003, I think it has a long and profitable future ahead of it.

Keep an eye out for forthcoming MLP-focused investing columns. In the meantime, if today's surely scintillating read has left you hungry for more great dividend investing ideas, check out this free Motley Fool special report: "Secure Your Future With 9 Rock-Solid Dividend Stocks." The title says it all. Get your copy while it's still available and the stocks are still hot.

At the time thisarticle was published Fool contributorJohn Grgurichloves master limited partnerships so much he wants to marry one, but he owns no shares of any of the companies mentioned in this column. Follow John's Foolish dispatches from the tumultuous front lines of capitalism on Twitter@TMFGrgurich.Motley Fool newsletter services have recommended buying shares of El Paso Pipeline Partners and Alliance Resource Partners. The Motley Fool has a page-turner of a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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