This was originally published on RealMoney. It is being republished as a bonus for TheStreet.com readers.In investing, a little means a lot. With no definite end in sight for declining real estate values and major financial institutions continuing to write off billions in loans, the key to beating this market is to get through this storm relatively unscathed. Equity dividends offer one intelligent way to protect your portfolio from the perils of both declining equity prices and creeping inflation. While no investment should ever be made on the basis of dividend yield alone, dividends can play a substantial role in determining the value of your assets over the long term. Consider what the typical 2% to 3% dividend yield can mean over 10 years: $100,000 that earns 11% per year over 10 years is worth about $284,000, while $100,000 that earns 13% over 10 years is worth about $340,000. With savings rates currently paying less than the current rate of inflation, savings accounts are actually paying you a negative real rate of return. And with the recent shutdown of several apparently sound banks, it would seem that putting your money under your mattress is your best bet. This is hardly the case.
Generally, the market gets its right. An astronomically high dividend yield is usually a precursor to a cut in the dividend. Such is a case in point with the financials. Getting caught in a dividend trap is akin to a catching a falling knife. The dividend loss comes along with a declining stock price. Part of the intrinsic value of a dividend-paying stock rests on the expected dividend payment over years. This valuation is commonly known as the dividend discount model, which values a company on the basis of the discounted sum of all its future dividend payments. Solid Bets However, when you do find solid dividend plays, the impact can be tremendous. Consider the following investment situation. In 2003, shares in the Chinese oil company PetroChina ( PTR - Get Report) were trading in the $30s. At the time, the stock had a dividend yield of around 6%-7%. According to the annual report at the time, one the chairman's stated goals was that the company would continue pay out about 45% of profits in dividends. The company had solid reserves, its operating profit was around 85% of Exxon Mobil's ( XOM - Get Report), yet the company was trading for a fraction of Exxon's market value. The icing on the cake was that Warren Buffett owned a big block of stock. Odds were high that the dividend payment would be maintained and that the company's value would increase. Three years later, the stock was over $130 a share with a dividend yield of around 4%, or $5 a share. So at my purchase price in $40s, my effective dividend yield was now over 10% along with a three-bagger in terms of stock appreciation. This was a dream investment. Unfortunately, I don't have another PetroChina, but there are a couple of fantastic dividend plays in some fantastic businesses backed by solid assets that generate cash flow. (Don't miss " Free Cash Rules: AmEx, Mohawk") Energy Is Here to Stay Energy is one commodity that we all can agree is used more and more each year. One particular sector of the industry that has been down for a while is the group of energy trusts, which are also referred to as master limited partnerships (MLPs). I wrote in detail about them last month
on RealMoney. Energy MLPs are entities that engage in the stable production of oil and natural gas and then pay out substantially all of their operating cash flow to the shareholders (commonly referred to as unit holders). This setup exempts them from paying corporate taxes.
One of my favorite players in this industry is Linn Energy ( LINE). Linn operates one of strongest collection of natural gas producing assets in the mid-Continent region. The company currently pays a 12% dividend yield and the distribution coverage ratio of 1.57 times is strong for the industry. Ultimately, the success of future dividend payments hinges on the cash flow of a business. Linn has over a trillion cubic feet of proven reserves of natural gas. A typical buyout for stable natural gas producing reserves is about $4.50 per thousand cubic feet. So this would give Linn a base value of $4.5 billion, which equates to today's current enterprise value of about $4.5 billion. However, the company recently sold some speculative assets in the popular Marcellus shale region to XTO Energy ( XTO) for $600 million, which according to management was equal to 10% of the company's business. Sales proceeds were used to reduce debt, and that benefits the dividend payment. Additionally, the company is selling off other small assets that don't fit well the company's current goal of owning the strongest collection of stable producing assets while minimizing debt. All Aboard Another solid asset play worth a look is Eagle Bulk Shipping ( EGLE - Get Report), a shipping company that leases out its ships on time charters to business shipping the world's necessities: iron ore, grains, fertilizers, cement and coal. Currently, EGLE sports a dividend of 7%, and for the past four years, both strong and weak times for maritime shipping, Eagle has maintained and increased the dividend. Eagle's business is such that it bears no fuel price exposure: Fuel costs are borne by the businesses that charter the ships. Eagle also prefers to charter its ships for a couple of years, thus stabilizing the cash flows. This strategy is a double-edged sword, as Eagle loses out on any spikes in shipping rates but benefits when rates decline. Nonetheless, Eagle's huge fleet benefits from its staggering charter schedule, thus minimizing its exposure to swings in shipping rate. A word of caution: Eagle has generally preferred to issue equity to acquire additional ships, thus diluting existing shareholders. Nonetheless, the additional ships are sailing at full capacity, so cash flow increases. And with no exposure to fuel costs, Eagle is a wonderful bet on long-term global trade. Dividends certainly aren't the be-all and end-all. But in this market, preservation of capital is the holy grail of investing. So businesses operating hard stable assets that are generating cash flows that are returned to investors via dividends are worth a look. This was originally published on RealMoney on August 18, 2008. For more information about subscribing to RealMoney, please click here.