The Coming Bubble in MLPs

It was difficult to make a buck in 2011. Those who had a job thanked their lucky stars.

And if you had some capital to invest, trying to turn a profit was just brutal. The Dow was up 5.5% for the year, but it sure didn’t feel like it. The S&P 500 finished almost exactly where it ended 2010. In fact, it was just 0.04 points away from the final 2010 number. The Nasdaq was down 1.8%.

Gold gained 10%, but went through some wild swings, punishing investors who jumped on the bandwagon.

And if you wanted to simply sit back and collect interest, good luck. Money markets, CDs and savings accounts yielded next to nothing. Treasuries weren’t much better.

So it’s no surprise that investors started to rediscover dividend-paying stocks as the one place they could make a few dollars.

I expect that trend to continue in a big way this year. In fact, in December, I made several predictions for 2012. Among them, MLPs (master limited partnerships) would become trendy.

The more I think about it, the more I’m convinced this class of stocks will not only be trendy, but become white hot to the point where pundits will be using the “B” word – “bubble.”

Several factors will lead to the “bubblicious” gains in these stocks, which are usually energy related.

1. Investors’ desperate search for income – Dividend stocks were all the rage in 2011 as investors tried to get yield anywhere they could find it. MLPs typically have yields above 5% since they must distribute all of their income back to unit-holders in order to avoid corporate taxes. The result is a yield that’s greater than the typical dividend-paying stock.

2. Energy experts Dave Fessler and Matt Carr expect energy prices to rise in 2012 – For some MLPs, the price of oil and gas doesn’t matter as they simply transport the stuff from point A to point B. For others it does, and higher prices mean higher profits and higher payouts to unit-holders.

3. Tax deferred strategy – Most, if not all, of MLPs’ distributions are usually not taxed by the IRS as ordinary dividends. Instead, they’re treated as a return of capital. This lowers your cost basis, which could increase your capital gains when you sell the stock. But while you’re collecting the cash distribution, you won’t be taxed on the distribution in the year you receive it. That can be attractive, particularly those in higher tax brackets.

4. Media frenzy – For all of the above reasons, I expect MLPs to get hot in 2012. The media will surely notice. Soon, you’ll see MLPs being talked about in the mainstream financial press, which will lead to more interest by investors, which will cause the stocks to go higher, which will generate more media attention.

I think the sector will get so hot, you’ll first see the naysayers come out, and then the believers forcefully defend their beloved MLPs. At some point the sector will drop and the bears will say, “I told you so.”

But their satisfaction will only last until the face-ripping rally that will come next as investors jump in on the newly created buying opportunity. The stragglers will keep the rally going, as they don’t want to be left out of the next great thing.

All of this attention will lead to utterances of the “B” word by the end of the year.

But a bubble isn’t always a bad thing – if you’re in early enough and get out when things get frothy.

If you’re interested in MLPs, take a look at companies like Williams Partners (NYSE: WPZ), Enbridge Energy (NYSE: EEP) and Buckeye Partners (NYSE: BPL)

I’m very bullish on MLPs right now. With those higher than average yields, if 2012 is a repeat of last year, MLPs might be one of the few places to make some real money this year.

Good Investing,

Marc Lichtenfeld

Article by Investment U