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Is Energy Transfer the Best Dividend Stock for You?

Energy Transfer (NYSE: ET) offers a monster dividend yield. The master limited partnership's (MLP) payout is over 8% these days. That puts it several times higher than the average dividend stock (the S&P 500's dividend yield is around 1.4%). Further, the pipeline company expects to grow its payout by 3% to 5% per year.

However, the MLP's big payout isn't for everyone. Here's how to determine whether it's the best dividend stock for you.

The case for buying Energy Transfer

The main draw of Energy Transfer is its lucrative cash distributions. The MLP currently pays its investors $0.315 per unit each quarter ($1.26 annually), putting its yield at around 8.2%. Put another way, every $1,000 invested into the MLP would produce about $82 in passive income each year.

That compares to about $14 of dividend income from an S&P 500 index fund. Further, distributions from MLPs are largely tax-deferred, meaning investors get to keep more of the income these entities generate each year. That income stream should steadily rise. Energy Transfer expects to increase its payout by 3% to 5% annually. A few factors fuel that view.

First, it has a relatively conservative dividend payout ratio (slightly more than 50%), giving it plenty of room to raise its distribution. Second, it invests a large percentage of its retained cash flow (about 40% of its total annual cash flow) into high-return organic expansion projects. It's investing $2.4 billion-$2.6 billion into growth projects this year, which should grow its cash flow.

Finally, the MLP has a strong balance sheet, giving it the flexibility to make accretive acquisitions. For example, it paid $7.1 billion to acquire fellow MLP Crestwood Equity Partners last year and another $1.5 billion to buy Lotus Midstream. Those and future deals will provide an additional income boost.

Overall, Energy Transfer should supply investors with a generous and steadily rising distribution. That high-yielding payout will make up most of the total return. However, with earnings likely growing at a low single-digit rate, it should have the fuel to deliver an annualized total return in the double digits.

The case against buying Energy Transfer

Energy Transfer can be a great option for many income-seeking investors. However, it might not be the best for everyone. One factor that might cause you to decide it's not right for you is that it's an MLP. While these entities can provide lucrative, tax-deferred passive income streams, they can complicate an investor's taxes. Instead of sending investors a Form 1099 at tax time, they send a Schedule K-1 (often later in the tax filing season). Those forms can cause a delay in filing taxes and make them more complicated (potentially requiring the service of an accountant).

Another reason Energy Transfer might not be best for everyone is that you often can't own its units in a retirement account, such as a Roth IRA or traditional IRA. These entities already provide tax-deferred income. On top of that, some MLPs trigger unrelated business taxable income (UBTI) liabilities.

Finally, some investors will likely prefer more growth than Energy Transfer offers. The MLP operates regulated pipelines and other midstream assets secured by long-term contracts. These structures supply the company with a very stable cash flow to pay distributions. However, they also limit its upside potential.

Further, the oil and gas industry isn't growing as fast as other sectors, like renewable energy. Because of that, Energy Transfer offers more moderate earnings growth and total return potential.

A great income option for some

Energy Transfer can be a great dividend stock if you don't mind the tax complications of an MLP and a lower earnings growth profile. For many investors, the lucrative, tax-deferred income stream more than makes up for its drawbacks. However, it's not the best dividend stock for those seeking simplified taxes or more earnings growth potential.

Should you invest $1,000 in Energy Transfer right now?

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Matt DiLallo has positions in Energy Transfer. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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