Focus on Future Yield

 | Mar 20, 2012 | 1:00 PM EDT
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It's been a big week around Chez Melvin. My daughter received a prestigious education award, and my son moved another wrung up the corporate ladder on his way to global domination. In baseball, the Wilpons pulled their assets out of the fire and will continue to own the New York Mets, which confirms that being an Orioles fan is not the toughest task in sports fandom.

Of course, one of the hot telephone conversations has been Apple's (AAPL) dividend and what it means for investors. Somehow, this flowed into another conversation about income investing and the dangers of chasing yield. It is a topic that we grizzled veterans like to consider; we've seen how this play has ended in the past, and balancing the need for income with a measure of safety is a great concern to us all.

One of the mistakes people often make is to focus only on a stock's current yield. While that is part of the picture, they miss one of the most exciting reasons to favor stocks over bonds for their income needs. A bond pays a fixed rate for a fixed period, but when investing in stocks, you have the potential for the dividend to be increased over time, allowing your income to grow from year to year. This growing income stream, along with the potential for capital appreciation from stocks, can offset the effect of inflation over time. Although that ugly beast has not reared its wealth-destroying head in a few years, that doesn't mean it has disappeared from the financial landscape. A growth-of-income portfolio is one of the best ways to protect your wealth when inflation returns to the economy.

I ran a screen this morning for stocks that not only offered a good yield, but had the potential for above-average dividend growth. I set the screener to produce a list of stocks that yielded at least 3% and had the potential for dividend growth of 10% or more annually over the next several years.

One of the names on the list is an old income favorite, BGC Partners (BGCP). The stock has not really appreciated much but it has paid steady dividends that have increased every year. In addition to its growing brokerage business, the company has moved into the commercial real estate markets as that sector of the economy has bottomed. It is buying commercial brokerage and management firm Grubb & Ellis out of bankruptcy protection to complement last year's acquisition of Newmark Knight Frank.

Although the two businesses do not appear to be related, history will prove this to be a brilliant move at a bargain price and add to the bottom line and shareholder payout for years to come. At today's price around $7.40, the shares yield a generous 9.2%. BGCP should be able to increase the dividend at a very rapid rate for the next few years. Value Line estimates the dividend will grow by more than 20% annually for the next three to five years.

Another intriguing growth-of-income story is Alliance Resource Partners LP (ARLP). This master limited partnership is in a terrible business right now; it owns coal mines and produces coal in the Illinois basin, as well as central and northern Appalachia. Coal is facing strong competition from low natural gas prices and the market is weak. Coal shipments are down substantially and are not soon likely to improve domestically.

Alliance, however, has made moves to offset weakness in the marketplace. All of 2012 and a good portion of 2013 production is already under contract with fixed prices. Management predicts another record year for the MLP. It would be the twelfth straight year of higher earnings and dividends for the company. Weaker coal prices will cause other producers to curtail production and that will eventually spark a price rebound. Meanwhile, Alliance is in a good position to increase its market share, as it has no immediate plans to cut production. At the current price around $66.84, the shares yield 5.9% and the dividend should grow by 10% for the next several years.

Don't make the mistake of only considering the current yield when shopping for income. Consider the potential for that income to grow in the future as well. I don't feel like there is a rush to buy anything right now, but there are signs the market is poised to move lower, so it's good to have your shopping list ready.

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