For the most part, you need money to make money, as the old saying goes. That’s because most ways of making passive income require an up-front investment. That’s true of dividend stocks, which are one of the easiest ways to generate passive income.
However, the amount of money you need to invest to achieve your income goals varies depending on a stock’s dividend yield. The higher the dividend yield, the lower the required investment.
Two companies with big-time yields are Energy Transfer (NYSE: ET) and Crestwood Equity Partners (NYSE: CEQP). Here’s a look at how much you’d need to invest into this high-yielding duo to achieve $1,000 of monthly income compared to other options.
The math to $1,000 in monthly income
Energy Transfer and Crestwood Equity Partners are master limited partnerships (MLPs) focused on the energy midstream sector. They operate pipelines, processing plants, and storage terminals that process and transport natural gas and other energy products. These businesses tend to generate very stable income backed by long-term contracts.
Meanwhile, MLPs must distribute the bulk of their earnings to investors to maintain their tax-advantaged status with the IRS. These features make them great for passive-income seekers.
Energy Transfer currently pays its investors $0.23 per unit each quarter ($0.92 per unit annualized), implying an 8.2% yield at the current price. Put another way, every $1,000 invested in Energy Transfer would produce $82 of annual passive income, or about $6.80 on a monthly basis.
Meanwhile, Crestwood Equity Partners pays its investors $0.655 per unit each quarter ($2.62 per unit annualized), giving it a 9.6% yield at the current price. That works out to about $96 of annual passive income for every $1,000 invested, or about $8 on a monthly basis. However, it’s worth pointing out that both MLPs make quarterly distributions on the same schedule, meaning you’d receive a lump sum payment each quarter from both MLPs.
These yields are significantly above average. They’re more than double the average energy stock and over six times the dividend yield of an S&P 500 index fund.
However, even with those big-time dividend yields, you’d need to invest a lot of money to achieve $1,000 of monthly income from these two stocks, as shown in the chart.
Current Income Yield
Annual Passive Income
Crestwood Equity Partners
On the other hand, you’d need to invest more than double that amount into the average energy stock to produce the same income. Meanwhile, it would require an almost $800,000 investment in an S&P 500 index fund to make $1,000 a month in dividends.
Weighing the risk and reward
Let me start by saying that $100,000 is a lot of money to invest in two stocks, especially for two companies in the volatile energy sector. That’s unless, of course, this would be a reasonable allocation in a well-diversified portfolio. However, even in that case, investors must keep risk in mind.
On the positive side, Energy Transfer and Crestwood Equity Partners are less risky than oil and gas companies. Their midstream operations generate steady cash flow as they process, transport, and store oil and gas. Meanwhile, they both have solid financial profiles to support their high-yielding payout. Crestwood expects to cover its distribution with cash by more than two times this year, while Energy Transfer’s coverage ratio was over three times in the first quarter. That enabled these MLPs to retain enough cash to fund their expansion programs with room to spare, allowing them to strengthen their balance sheets.
However, these MLPs have run into financial troubles in the past. Both have reduced their payouts during turbulent market conditions to retain more cash to fund expansion and reduce debt. While they’ve both come a long way over the years, neither has achieved their leverage target. This means if there’s another unexpected downturn in the energy market, both might have to reduce their payouts again.
That risk aside, these MLPs seem more likely to increase their payouts than cut them in the future. Crestwood gave its investors a 5% raise earlier this year, while Energy Transfer has boosted its payout by 50%. They could continue increasing them down the line. Energy Transfer aims to get its distribution back up to its former peak. Meanwhile, Crestwood wants to return more cash to investors next year, when it should achieve its leverage ratio thanks to surging free cash flow.
Big-time income producers
Energy Transfer and Crestwood Equity Partners generate more passive income for their investors than many other dividend-paying stocks. All this means you won’t need to invest as much to achieve your passive income goals with this duo.
However, solely investing in these MLPs would be a high-risk gamble, even though their payments should rise in the future. Given those risk factors, they’re best as part of a well-diversified income portfolio, where they can do some but not all of the heavy lifting.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Matthew DiLallo has positions in Alphabet (C shares), Crestwood Equity Partners LP, and Energy Transfer LP and has the following options: short October 2022 $8 puts on Energy Transfer LP. The Motley Fool has positions in and recommends Alphabet (A shares) and Alphabet (C shares). The Motley Fool has a disclosure policy.