As the year winds down, here are my thoughts for what lies ahead in 2012 for income investors.
Prediction #1: The “Crowded Trade” Chatter Heats Up
Many Wall Street pros are scoffing at buying stocks with solid dividends. I believe this is for two reasons:
- The first is that in order for the Wall Street machine to make money, and that includes the financial media, you need to be trading constantly, generating commissions and hanging onto every word as to which stocks will go higher and which are going to tank.If you’re investing in dividend paying stocks, chances are you’re in it for the long term. And the only people who make money off you are fee-based financial advisors, but you probably don’t need one of those to put Duke Energy (NYSE: DUK) in your portfolio and not touch it for the next 10 years.
- The second reason is because Wall Street is viewing these stocks incorrectly. They’re calling it a crowded trade, not an investment. Investors who tend to buy dividend stocks usually aren’t actively trading them. They’re not jumping into them because they’re hot. They’re buying the stocks because they provide a higher level of income than other available investments. Income investors are just that – investors, not traders.
No doubt, there are some traders in these stocks. Defensive names in healthcare, particularly big pharmaceuticals like Bristol-Myers Squibb (NYSE: BMY) and utilities have been very strong lately.
I expect a pullback at some point as traders exit and chase the next hot thing. But for the year, I believe stocks that pay a healthy dividend will continue to outperform as investors (not traders) search for yield in what should remain a very low interest rate environment.
Prediction # 3: MLPs Will Become Trendy
The investing story of the year could be MLPs (master limited partnerships). These are companies, the majority of which are energy related, that distribute nearly all of their profits back to unit-holders.
MLPs are different than regular stocks in that the unit-holders (not shareholders) are partners in the business. The company isn’t subject to a corporate tax because it passes its profits to the owners in the form of a cash distribution.
As a result, yields on these stocks are often higher than many other stocks. For example, Enterprise Products Partners (NYSE: EPD) yields 5.4 percent, while Energy Transfer Partners (NYSE: ETP) sports a yield of 7.8 percent.
What also makes these investments attractive is that usually most, if not all, of the distribution is tax deferred. When you receive a distribution from a MLP, it isn’t taxed as an ordinary dividend. It’s treated as a return of capital, which lowers your cost basis. So instead of paying tax on a dividend in the year it’s received, you pay capital gains tax when you sell the stock.
For example, if you buy a MLP for $30 and receive a $2 distribution, your new cost basis is $28. Next year, when you receive another $2, your cost basis falls to $26. If you sell the stock at $30, you will report a capital gain of $4, but you will not have paid any taxes on the $4 during the years you received them.
Because this is a tax-deferred strategy, MLPs usually belong in your taxable accounts, not your IRAs.
As always, with tax matters, consult your tax professional so that you completely understand the implications of owning a MLP.
If dividend stocks remain popular, their yields will go down and investors will widen their search for income. They’ll end up in MLPs, which will be the hottest sector of the year. By the fourth quarter, pundits will be using the “bubble” word.
Prediction #4: Apple Declares a Dividend
There are a lot of Apple (Nasdaq: AAPL) shareholders who are demanding that the company part with some of that $26-billion cash hoard. While Apple is still growing and innovating, it’s no longer a young company that must clutch its wallet like George Costanza at French Laundry (a $300 per person restaurant in Napa County, California).
Compared to other tech companies like Microsoft (Nasdaq: MSFT) and Intel (Nasdaq: INTC), which also have tons of cash but pay dividends, Apple has even stronger numbers and should be able to institute a dividend easily.
Intel and Microsoft paid dividends equal to roughly 20% of cash flow from operations. It seems like Apple should be able to do the same.
I wouldn’t be surprised to see $7 billion or so put to work on behalf of shareholders. Some may be used in a buyback with the rest paid out in dividends during a 12-month period beginning in 2012.
It will probably be some combination of a special dividend and a small regularly paid dividend that will increase over time.
My official prediction – a $4-billion stock buyback will be authorized with another $3.5 billion allocated for dividends, split evenly between a one-time special dividend and a quarterly dividend.
The quarterly dividend will start out at roughly $0.39 per share, and will increase over time.
There’s already heat on the board to pay shareholders something. If my above predictions come true and dividend stocks are hot while others are not, the board may feel additional pressure to pay a dividend in order to show up on the radar of income seekers.
Next year should be another good one for investors in dividend payers, regardless of what the naysayers think.
I hope 2012 is a happy, healthy and lucrative year for you.
Source: Investment U