The Best Income Investment for the Next 5 Years

April 9, 2014
Alexander Green

Five years is an eon in the investment world, especially for income investors. So where does such an investor put his or her money to work for the next 5 years?

This article is published with permission from InvestmentU.com.

At the recent Investment U Conference in Carlsbad, CA, each speaker was asked to name their "Single Best Income Idea for the Next 5 Years."

I wrestled with this one for a few weeks, but I believe my final candidate was a good one. We don't ordinarily give specific investment recommendations in our Investment U columns. But I am going to share this recommendation with you today because I want to reveal the thought process that went into it. Let me start at the beginning…

Five years is an eon in the investment world. (You might recall that the consensus 5 years ago was that the world was coming to an end.) No one knows what the investment landscape will look like in 2019.

And it is especially tough for income investors. As I've mentioned before, we are now in a period of what I call "administrative markets." Both stocks and bonds are being influenced nearly as much by the government—and especially Fed policy—as by inflation, economic growth, or corporate earnings.

Why is it tougher for income investors? Because I don't think enough investors realize that when the Federal Reserve holds interest rates artificially low with its quantitative easing program, it is simultaneously holding bond prices (and especially Treasurys) artificially high.

Why would anyone want to buy something whose price is being artificially propped up by the government? Five years from now, quantitative easing is likely to be as much a distant memory as the Troubled Asset Relief Program is now. Interest rates will normalize. Bonds, almost certainly, will produce meager returns for the next 5 years.

Anything that is highly sensitive to interest rate changes is likely to be negatively impacted. That includes not just high-grade bonds but preferred shares, utilities, real estate investment trusts, etc.

What to do

So where does an income investor put his money to work for the next 5 years? My answer is in dividend-paying stocks.

"But wait," you might rightly ask, "what if we're in the midst of a bear market in 5 years?"

In that case, the 5-year total return on a dividend stock may well be negative. Of course, you run this risk with any stock you buy at any time, but it would clearly be safer to buy a stock in an asset class that was down instead of near a 5-year high.

And we have just that in emerging markets today, an equity class that has been quietly pounded while U.S., European, and Japanese stocks have pushed higher.

Emerging markets—whatever their performance in the near term—might be a good place to look for a high-dividend-paying stock over the next 5 years. But we want a margin of safety. We want a company whose products are virtually guaranteed to be in demand 5 years from now.

Certainly energy—and especially oil and gas—fits the bill. And so I ended up recommending Ecopetrol (NYSE: EC).

Based in Bogota, Columbia, Ecopetrol is a $17 billion oil and gas producer that accounts for almost two-thirds of that country's energy sector. Earnings are likely to hit nearly $4 a share this year. That means it sells at just 9 times prospective earnings.

Other financial metrics look good, too. The company's operating margin is 31%. Management is earning a healthy 19% return on equity. And the company is sitting on nearly $6 billion in cash.

The stock is down over the past year for 3 primary reasons. The first is that oil and gas companies have underperformed worldwide. The second is that emerging markets have sold off. The third is that investors have legitimate concerns about Columbia's political situation. But this company will survive any political turmoil. And it is globally diversified, with operations in Brazil, Peru, and the U.S.

Prospects brightening

Things are looking up in Columbia from an economic standpoint. The central bank there has cut interest rates 7 times in 10 months. The result is robust economic growth. The Columbian economy is growing at 5.1%.

At Ecopetrol, average daily production is up. The company's proven reserves just reached 1.9 billion barrels. That's an increase of 74% over the last 4 years.

What if the company depletes its reserves? Not likely. Its reserve replacement ratio is currently 139%. That means it is adding 1.39 barrels to its reserves for every barrel it produces.

And the dividend? Ecopetrol currently yields 8%. And with production rising, that dividend is likely to be maintained or increased in the years ahead.

I certainly can't tell you what the best-performing income investment will be over the next 5 years. But I'm willing to bet that Ecopetrol outperforms 90% of the alternatives.

Treasurys yield less than 3% and money markets pay next to nothing. Ecopetrol could drop 3% a year for the next 5 years and—with its dividend—still generate a higher total return than these.

Is there risk here? Of course. We can't control oil prices or the performance of emerging markets or the government of Colombia.

But emerging markets are cheap. Ecopetrol is undervalued. The dividend is secure. And this stock is likely to generate a very attractive total return over the next 5 years.

Alexander Green is the chief investment strategist at InvestmentU.com. See more articles by Alexander here.

The information contained in this article should not be construed as investment advice or as a solicitation to buy or sell any stock. Nothing published by Physician’s Money Digest should be considered personalized investment advice. Physician’s Money Digest, its writers and editors, and Intellisphere LLC and its employees are not responsible for errors and/or omissions.