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The Potential Bomb Hiding in Your Safe Income PortfolioBy
Saturday, July 24, 2010
If you're a serious income investor, chances are you have pipeline companies in your portfolio right now.
Longtime readers of my income advisory (The 12% Letter) do. In November 2008, near the depths of the bear market, I recommended two pipeline businesses, Kinder Morgan Partners (KMP) and Enterprise Product Partners (EPD).
Pipeline companies – the firms that collect, distribute, and store fuels like natural gas – are one of the best businesses in the world for collecting income. Once you've buried your pipe, you can sit back and collect fees from your customers. Many of the natural gas pipelines we use today were in the ground before World War II. They'll still be cranking out profits another 65 years from now.
Pipelines require little ongoing investment, they assume no commodity price risks, and they have no way to grow. They simply crank out earnings month after month for decades at a stretch. And because gas pipelines are so important to the economy, the government gives them huge tax breaks to make sure they receive plenty of investor money.
Pipelines mainly transport natural gas. This is another huge benefit. Over the last five years, the natural gas industry has figured out how to exploit America's massive supplies of shale gas, and gas pipelines are more valuable than ever.
Right now, pipeline companies are absolutely soaring in price. Kinder Morgan and Enterprise Product Partners, the two companies I consider the "beachfront real estate" of the pipeline sector, have returned 63% and 94%, respectively, since I recommended them 18 months ago. The benchmark pipeline index has reached a new high almost every single day for the past two months.
Here's the problem... when a normally boring income-related sector catches fire, like pipelines have recently, I don't start buying more. I start looking for the exit.
The best time to enter a sector like pipelines is when nobody wants to touch it. (That's why I was telling you to buy in fall 2008.) When everyone is scared to death of these stocks, you can pick up yields of around 10%.
The best time to exit a sector like pipelines is when people are going wild for it. This is usually when prices have climbed... which pushes down the current yields. In November 2008, for example, Kinder Morgan paid a 9% dividend. Today, it yields just 6%.
If you already own any of these stocks, I urge you to keep holding. With all the momentum behind these companies right now, your shares could easily rise another 25%-50% in a short time period. But make sure you use a trailing stop loss to protect your big gains. Enjoy the uptrend, but move closer to the exit doors.
If you don't already own these stocks, now is NOT the time to buy. At the current high prices and low dividend yields, pipeline stocks are simply too risky for your safe income portfolio. Remember, we want to buy assets people are willing to sell at any price... and sell those assets when the market is going wild for them.
Pipeline stocks are great income investments... but you should only buy them when they're cheap and offering high yields, and when they're not being touted by Wall Street to any investor that'll listen.
While this big uptrend could easily generate more gains, the big, easy, safe money – the kind I'm interested in – has already been made.
Good investing,
Tom
Further Reading:
With traditional high-yield investments – like pipeline stocks – out of buying range... and with the Fed holding rates at zero... it's gotten harder to generate a safe, steady stream of cash. But Tom just showed DailyWealth readers how to collect a guaranteed 7% a year without risking a penny. Get the details here: How to Make a Safe 7% Interest in a 0% Interest World.
Market NotesCHART OF THE WEEK: GOLD AND APPLE – A GOOD PAIR This week's chart is a tale of two "crisis-beating" assets. Gold and Apple (NASDAQ: AAPL).
In the past three years, just about every asset you can think of has either lost money or treaded water. The 2008 credit-crisis selloff was so severe, even recent rallies haven't been able to carry assets back to their levels of a few years ago. Two exceptions here are gold and shares of Apple.
Below is what's called a "performance chart." Performance charts graph the percentage returns of assets against each other. In this case, it's the past three years of gold (gold line) and Apple shares (blue line).
Amazingly, both assets have registered the same gains since mid-2007... around 80%. Gold is enjoying price strength because of its role as "real money" crisis insurance. Apple is enjoying brand dominance in phones and music players. It's a heck of a "pairs trade."
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Stat of the week
-0.48%
The "real yield" on the U.S. two-year Treasury bond. The real yield is the interest you earn on a bond after inflation is taken into account. In other words, people are paying Uncle Sam to hold their money. In The Daily Crux
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